On the Optimal Adherence to Money Targets in a New-Keynesian Framework: An Application to Low-Income Countries

By Andrew Berg, Filiz D Unsal, Rafael A Portillo

June 1, 2010

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Andrew Berg, Filiz D Unsal, and Rafael A Portillo. On the Optimal Adherence to Money Targets in a New-Keynesian Framework: An Application to Low-Income Countries, (USA: International Monetary Fund, 2010) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Many low-income countries continue to describe their monetary policy framework in terms of targets on monetary aggregates. This contrasts with most modern discussions of monetary policy, and with most practice. We extend the new-Keynesian model to provide a role for “M” in the conduct of monetary policy, and examine the conditions under which some adherence to money targets is optimal. In the spirit of Poole (1970), this role is based on the incompleteness of information available to the central bank, a pervasive issues in these countries. Ex-ante announcements/forecasts for money growth are consistent with a Taylor rule for the relevant short-term interest rate. Ex-post, the policy maker must choose his relative adherence to interest rate and money growth targets. Drawing on the method in Svensson and Woodford (2004), we show that the optimal adherence to ex-ante targets is equivalent to a signal extraction problem where the central bank uses the money market information to update its estimate of the state of the economy. We estimate the model, using Bayesian methods, for Tanzania, Uganda (both de jure money targeters), and Ghana (a de jure inflation targeter), and compare the de facto adherence to targets with the optimal use of money market information in each country.

Subject: Demand for money, Inflation, Monetary aggregates, Output gap, Short term interest rates

Keywords: Interest rate, WP

Publication Details

Pages:

31
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2010/134
Stock No:

WPIEA2010134
ISBN:

9781455201174
ISSN:

1018-5941

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