The Optimal Choice of a Monetary Policy Instrument

Andrew Atkeson, Vyjayanthi Chari and Patrick Kehoe ()

No CAS_RN_2007_1, Working Papers from Laboratory for Macroeconomic Analysis

Abstract: Monetary policy instruments di¤er in tightness. how closely they are linked to in.a- tion. and transparency. how easily they can be monitored. Tightness is always desirable, while transparency is desirable only if policymakers cannot commit to future policies. We show that because interest rates can be made endogenously tight they have a natural advantage over both money growth and exchange rates. We also show that interest rates and exchange rates, because they are prices, are more transparent than money growth and thus have a natural advantage over money growth. Our model provides some insights into why developed economies tend to use inter- est rates as their primary policy instrument and why less-developed economies, in which interest rates are not available as an instrument, tend to use exchange rates.

New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2007-11
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