Question

Name two monetary policy rules, either proposed or actual.

Answer 1

The two most famous monetary policy rules are as follows:

1) Taylor’s interest rate rule.

As per this rule, a target for the short-run interest rate is set.

Whenever inflation or output in the economy is above the desired rates, the monetary authority would raise the target rate by adopting a contractionary monetary policy stance.

If inflation and output are below desired levels, the monetary authority would increase the supply of loanable funds, thus lowering the interest rate, thereby adopting an expansionary monetary policy stance.

2) Inflation targeting rule.

As per this rule, an inflation target would be set, say at 1%.

The money supply will be adjusted every predetermined time period by 1%.

This targeting could destabilize the economy if income and employment are reduced due to other factors in the economy, thus increasing inflation at a faster rate than the target.

Inflation targeting rule would raise the prices of goods and services without a corresponding increase in the quantity of money.