Efficient Rules for Monetary Policy

Abstract

This paper defines an efficient rule for monetary policy as one that minimises a weighted sum of output variance and inflation variance. It derives several results about the efficiency of alternative in a simple macroeconomic model. First, efficient can be expressed as rules in which interest rates respond to output and inflation. But the coefficients in efficient Taylor differ from the coefficients that fit actual policy in the United States. Second, inflation targets are efficient. Indeed, the set of efficient is equivalent to the set of inflation-target policies with different speeds of adjustment. Finally, nominal-income targets are not merely inefficient, but disastrous: they imply that output and inflation have infinite variances.