Research Discussion Paper – RDP 9007 Operating Objectives for Monetary Policy
November 1990
Abstract
This paper investigates simple monetary policy rules using a theoretical model of a small open economy. The anlysis is intended to highlight two problems in policy formulation that are of particular importance to Australia: instability of the money demand function, and exposure of the economy to external shocks. Among the class of simple rules that are considered, it is shown that nominal income targeting consistently gives the lowest short-run variability of real output. In particular, such a policy outperforms both a monetary target and a fixed exchange rate. Problems of inaccurate information and recognition lags reduce the attractiveness of all targeting rules relative to the alternative of fixing the exchange rate. However, these problems do not provide grounds for a return to simple forms of monetary targeting.