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

32 Pages Posted: 21 Jun 2010

See all articles by Andrew Berg

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division

Rafael Portillo

International Monetary Fund (IMF)

D. Filiz Unsal

International Monetary Fund (IMF) - Research Department

Date Written: June 2010

Abstract

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 issue in these countries. Ex-ante announcements and 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.

Keywords: Central bank policy, Cross country analysis, Economic models, Ghana, Low-income developing countries, Monetary aggregates, Monetary policy, Money, Tanzania, Uganda

Suggested Citation

Berg, Andrew and Portillo, Rafael and Unsal, D. Filiz, On the Optimal Adherence to Money Targets in a New-Keynesian Framework: An Application to Low-Income Countries (June 2010). IMF Working Paper No. 10/134, Available at SSRN: https://ssrn.com/abstract=1627069

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8843 (Phone)
202-589-8843 (Fax)

Rafael Portillo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

D. Filiz Unsal (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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