A Keynesian macroeconometric framework for the analysis of monetary policy rules

Abstract

In the framework of a Keynesian based monetary macro model, we study the implications of targeting monetary aggregates or targeting the interest rate as two alternative monetary policy rules. Whereas the former targets the inflation rate indirectly, through the control of the money supply, the latter, also called the Taylor rule, implies direct inflation targeting. Our monetary macro model exhibits: asset market clearing, disequilibrium in the product and labor markets, sluggish price and quantity adjustments, two Phillips curves for the wage and price dynamics and expectations formation which represents a combination of adaptive and forward looking behavior. The parameters of different model variants are estimated partly through single equation and partly through subsystem estimations for US quarterly time series data 1960.1–1995.1. With the estimated parameters system simulations for the two monetary policy rules are performed. Although the two rules have slightly different stability properties, we show that discretionary monetary policy, i.e. policy that responds to the state of macro variables, has stabilizing effects. We also show that our model with either of the two rules generate in terms of impulse response functions roughly the same responses to shocks as one obtains from standard VAR studies.