Evaluating Mccallum's Rule When Monetary Policy Matters

This paper provides new evidence on the usefulness of McCallum's proposed rule for monetary policy. The rule targets nominal GDP using the monetary base as the instrument. We analyze the rule using three very different economic models to see if the rule works well in different environments. Our results show that while the rule leads to lower inflation than there has been over the last 30 years, instability problems suggest that the rule should be modified to feed back on the growth rate of nominal GDP rather than the level. This paper addresses three aspects of McCallum's proposed rule: (1) it expands the set of models used to evaluate McCallum's rule; (2) it shows how impulse responses can be used to evaluate the stabilization properties of McCallum's rule in our models; and (3) it provides a more detailed accounting of how the rule affects the endogenous variables in our models. Following McCallum and Judd-Motley, we also use our models to conduct stochastic simulations, with McCallum's rule determining the monetary-policy response to disturbances. McCallum's rule is a potentially useful rule for setting monetary policy. Had the rule been followed over the past 30 years, inflation would have been much lower than it actually was. Given the concern over inflation that arose in the 1970s and early 1980s, McCallum's rule could serve as a useful device to guide monetary policy today. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Philadelphia or of the Federal Reserve System