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Stabilization, Accommodation, and Monetary Rules

A central feature of the monetarist approach to the problem of inflation is a preannounced gradual reduction in monetary growth. This reduction is to be sustained until a monetary growth consistent with a zero, or acceptably low, target rate of inflation is reached. Thereafter, monetary growth is to be held constant at this new rate. The specifics of this prescription differ by the type of monetary measure used for calculating growth rates - either high-powered money, a monetary aggregate, or nominal GNP - and by the length of the transition period during which the noninflationary growth is approached. The prescriptions are alike in ruling out contingent deviations from the plan should economic conditions change, either during the transition period or after the beginning of the constant growth rate rule. The plans are rigid, having no explicit contingencies. This rigidity has been the target of most critiques of monetarism. Stressing the inefficiencies which a noncontingent monetarist rule would entail, many economists have pointed out the advantages of alternative rules which react to economic events in a structured and stable way. Stanley Fischer and J. Phillip Cooper showed, through a series of examples, that these inefficiencies of monetarist rules exist even when lags are long and variable. The present paper is an attempt to examine quantitatively which operating characteristics of a monetarist rule are inefficient, and which are relatively efficient. Certain, if not all, features of monetarism could operate efficiently within the context of a particular model and a certain set of parameter values. Few econometric studies, however, have been designed to estimate the specific differences between a monetarist rule and an efficient rule, and to determine whether these differences are statistically significant. Is the monetarist rule inefficient because it is not countercyclical, or is it inefficient because it does not accommodate inflation? Or is it inefficient on both counts? The particular model used for this analysis is adopted directly from my 1979 econometric investigation. It is a small model with rational expectations and certain rudimentary types of inflation inertia. The model fits the U.S. economy fairly well, and some new complex variable techniques developed and applied to the model by David Livesey, enable a simple analytic treatment of efficient policy choice in place of less transparent numerical analysis. Using the results of Livesey, the differences between monetarist and efficient rules can be clearly and rigorously shown without reliance on numerical optimization or simulation techniques. The results indicate that the monetarist nonaccommodation of inflation seems to work reasonable well and, although some value judgements are required, does not generate significant output instabilities. On the whole, however, the monetarist rule is inefficient. The inefficiencies arise mainly because of its rigidity with respect to business cycle developments. Some moderate countercyclical monetary responses can help to stabilize the economy. In fact, a classic countercyclical monetary policy combined with no accommodation of inflation is nearly efficient.