Monetary Policy

What are the different types of monetary policy rules?

• Taylor Rule, Balanced Approach Rule, Balanced Approach (Shortfalls) Rule, Adjusted Taylor (1993) Rule, and the First Difference Rule

• Each one shows a different monetary policy response, with slightly different weightings on inflation and unemployment deviations

• The adjusted Taylor (1993) rule is the only one which recognises that the FFR can’t be set materially below the effective lower bound

  • It proposes changing the interest rate only after the economy has begun to recover

Limitations of different policy rules

• Often tested in conditions which have less variables and are unlike the actual conditions the FOMC considers, meaning their results often abstract away from real conditions

• They also often do not take into account the effective lower bound on interest rates

• Simply policy rules also don’t take other monetary policy tools into account, like balance sheet policies

Policy rule prescriptions in the pandemic

• All of the simple monetary policy rules allowed for a very accommodative stance of monetary policy in response to pandemic inflation pressures

• For most of 2022, the rules prescribed a rate between 4 and 8 %, which was much higher than the levels actually observed in the pandemic, perhaps due to elevated inflation readings

  • For most of 2022, the actual target range for the FFR was below the prescribed policy rates, but this gap has lessened as the FOMC has tightened the stance of monetary policy

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