Design flaws in the construction of monetary conditions indices? A cautionary note

Alfred Guender and Troy Matheson ()

New Zealand Economic Papers, 2002, vol. 36, issue 2, 209-215

Abstract: Monetary conditions indices featured prominently as instrument variables or operating targets, particularly in the inflation-targeting countries during the 1990s. In this paper, we show that conventional monetary conditions indices are potentially mis-specified. Under a regime of strict inflation targeting, conventional MCIs are unreliable indicator variables or operating targets if there is a direct exchange rate effect on the rate of inflation in the Phillips Curve. We also point to the limitations of a standard MCI under strict inflation targeting. The policymaker can circumvent these limitations by redefining the inflation target. Nevertheless, from a general perspective the usefulness of MCIs in the conduct of monetary policy is doubtful in view of their model-specific nature.

Keywords: Monetary Conditions Index (MCI); Strict Inflation-Targeting; Direct Exchange Rate Channel; Misspecification (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1080/00779950209544371

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