An Evaluation of Alternative Indicator Regimes for Monetary Policy

This Paper evaluates alternative designs of indicator regimes for monetary policy in a small stochastic macromodel of the small open economy with rational expectations. The paper first derives methods for deriving optimal control rules and optimal simple feedback rules in rational expectations models, taking account of the Lucas critique. Use of the money supply, exchange rate, nominal income and price level as alternative indicators for monetary policy are then considered, with the objective of minimising a linear combination of price and output fluctuations. The price level indicator regime is found to be robust in the face of different types of disturbance and parameter changes. Moreover, this regime generally dominates the other regimes, and exhibits only a slight increase in loss relative to the full optimal rule.