II. Monetary policy design and criteria for assessing monetary policy rules 21
II. Monetary policy design and criteria for assessing monetary policy rules In this chapter, I provide a more general perspective to the main theoretical and practical issues in monetary policy design, which are relevant for the assessment of the several interest rate rule specifications in the subsequent parts. The issues covered in Section 1 include the advantages and implications of systematic pol- icy behaviour (as opposed to discretionary measures) and choice of instru- ments/target variables that enter the rule specification. In addition, Section 2 presents the main criteria that will be used in the subsequent determinacy and impulse response analysis in Chapters III and IV. The Taylor principle, which forms the basis for the classification of monetary policy rules in terms of the de- gree of their “activeness” (measured by the size of the inflation response coeffi- cient), is presented formally in the last subsection. Later on, in Section 4 in the subsequent chapter the main findings will be centred on the question whether adherence to the Taylor principle guarantees a determinate rational-expectations equilibrium when endogenous capital with adjustment costs is introduced to a New Keynesian model with staggered price-and wage-setting. 1. Monetary policy issues In the 1960s and 1970s “activist” monetary policies, aimed at achieving “full employment” have been widely discussed and implemented5. The rise of such policies has been motivated by the conviction that there exists a stable long-run trade-off between inflation and unemployment, captured by the Phillips curve6. According to this view, in the long run the...
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