Price stability and monetary policy: A proposal of a non active policy rule

A new type of monetary policy rule designed to achieve both price and output stability has increasingly been recommended during the last business cycle expansion, prior to the 2007 crisis. This type of rule implies "active" reaction functions. Based on the new Keynesian approach to monetary economics, these rules prescribe an active response by the central bank in the face of any shock that shifts prices or output from target, which leads to excessive money creation. Here, a less active type of reaction function is proposed; one in which price stability is the long run target, but permitting prices to respond to changes originating in real disturbances. It is argued that the resulting policy delivers outcomes preferable to currently popular rules.