Abstract
This paper demonstrates that, despite the current mandate of monetary policy, its final goal (at least for central banks of developed countries) is the control of three main macroeconomic variables — economic growth, employment and inflation, — regardless on actual mandate for this policy. However, the priorities of realization of the final goal may face the imperfection of macroeconomic models and rules of monetary policy, which will make it impossible to control all three macroeconomic variables at the same time. The article proposes a new instrument for monetary policy — aggregate cumulative market imperfection — to optimize macroeconomic variables and stabilize cyclical economic dynamics. The author demonstrates the main competitive advantages of this instrument of monetary policy as compared with typical models of macroeconomic dynamics and simple rules of monetary policy (Simons, Friedman, and Taylor rules). In particular, this instrument is valid for any combination of market conditions, for any economy and for any moment of real time. It can be used simultaneously as: 1) a target of monetary policy; 2) a simple rule of monetary policy correction in the short-run; 3) a reaction function to evaluate a backward connection between the regulator’s actions and the effect of these actions on current economic situation; and 4) an instrument to stabilize cyclical economic dynamics; 5) an instrument to forecast starting (ending) point of recessions and shift in macroeconomic trends. If we can hold the aggregate cumulative market imperfection within a given optimal interval with the help of government regulations (i.e. to target this indicator only) using all possible instruments both of monetary, and (if necessary) of other kinds of regulation policy, we will be able to optimize all three main macroeconomic variables. Optimality of these variables means providing maximum economic growth and employment under comfortable inflation for any combination of market conditions and for any moment of calendar time, which will at the same time stabilize cyclical economic dynamics. In doing so, we will not target each of these three variables separately, that is, it is practically impossible to determine quantitatively their optimal values as they change permanently over time together with the constant change of current combination of market conditions.
Highlights
At the November 1992 Carnegie Rochester Conference on Public Policy, John Taylor (1993a) suggested that the Federal funds rate (r) should normatively be set and could positively be explained by a simple equation: r = p + 1/2y + 1/2(p-2) + 2, where y = percent deviation of real GDP from trend and p = rate of inflation over the previous four quarters
Athanasios Orphanides’ (2003) examined ‘Historical Monetary Policy Analysis and the Taylor Rule’; this paper examines the intellectual history of the concept
This paper has described an important component of the transformation that swept through the monetary policy landscape in a remarkably few years following the abandonment of monetary targeting
Summary
At the December 1988 Macroeconomic Policies in an Interdependent World conference, several papers investigated policy rules At this conference, Taylor (1989b, 125, 138) had the short-run interest rate as the primary operating instrument of monetary policy: “placing some weight on real output in the interest rate reaction function is likely to be better than a pure price rule”. Taylor (1989b, 125, 138) had the short-run interest rate as the primary operating instrument of monetary policy: “placing some weight on real output in the interest rate reaction function is likely to be better than a pure price rule” This rules-based literature appeared not to be leading to a consensus. Taylor’s theoretical framework (in which his rule is embedded) embraced R (and in the background, though it is not required) N, replaced P with contracts, and provided a policy framework minus the inflammatory rhetoric
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