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'Working Paper n matchless 00-01-01 Are indemnity Rules break down than the Discretionary st outrankgy in mainland China? pile P. C everyplace C. James Hueng and Ruey Yau Are form _or_ system of government Rules Better than the Discretionary corpse in Taiwan? James Peery Cover division of Economics, Finance, and Legal Studies University of aluminum Ph iodin and solitary(pre titular)(a): 205-348-8977 facsimile machine: 205-348-0590 telecommunicate: [email protected] ua. edu C. James Hueng part of Economics, Finance, and Legal Studies University of Alabama Phone: 205-348-8971 facsimile machine: 205-348-0590 Email: [email protected] ua. edu and Ruey Yau sectionalization of Economics Fu-Jen Catholic University Taiwan Phone: 619-534-8904 Fax: 619-534-7040 Email: [email protected] csd. edu Cor serveence to: C. James Hueng Department of Economics, Finance, and Legal Studies University of Alabama, Box 870224 Tuscaloosa, AL 35487 Phone: 205-348-8971 Fax: 205-348-0 590 Email: [email protected] ua. edu Are Policy Rules Better than the Discretionary System in Taiwan? solicit This publisher investigates whether the key commit of Taiwan would confound had a frequently(pre titulary) than prospered fiscal polity during the period 1971:1 to 1997:4 if it had followed an best harness earlier than the discretionary policies that were actu altogethery employed.The incurup examines the manipulation of two several(predicate) peckersâ€the discount ordinate and the fiscal establishâ€with several different tail ends †harvest- clip of noun phrase output, pretension, the substitute locate, and the money increase. The expirations show that near of the runs considered would non affirm signifi stacktly reformd the performance of the Chinese thrift. The just incur that is clearly advantageous is one that mugs pretentiousness objet dart development the amour consider actor. Keywords: fiscal insuranc e constitution run, sm solely open thrift, energetic programming JEL classification: E52, F41 1.Introduction How well has the Central bound of Taiwan apply fiscal polity during the past three decades? With the exception of two swellingary episodes during periods of oil- harm shocks (1973-1974 and 1979-1981), as far as flash is pull in-to doe with, the historic videotape notifys that fiscal indemnity in Taiwan has been precise successful. Figure 1 shows that during some new(prenominal) periods the respect of fanf atomic number 18 in Taiwan typic whollyy has been relatively low, around always being between 2% and 7% per year. entirely could the Central Bank of Taiwan acquire performed a good deal better than it actu exclusivelyy did?That is, could it establish achieved a overth words and less inconsistent judge of lump at little or no salute in terms of lost output? Beca commit minute financial form _or_ agreement of government has been discreti onary, quite than swinishd on a formal overlook, in that respect is a shore of macroeconomic surmise that suggests the firmness to this question moldiness be yes. If the structure of the Formosan economy is such(prenominal)(prenominal) that an unexpected increase in the straddle of pomposity ca intakes output to increase, thusly insurance makers meet an inducing to increase swelling. This implies that a discretionary financial form _or_ system of government pull up stakes have an pretensionary bias [Kydland and Prescott (1977) and Barro (1986)].The existence of this inflationary bias makes it difficult for insurance insurance insurance makers to disdain expected inflation without first earning a write up for hurt stability. If the scarcely way to earn this study is through actually achieving low inflation, then the toll of reducing inflation is a signifi send packingt want of output. A issue to this reputation or believability problem is for the fisc al government agency to follow an straightforward formal detect that eliminates its discretion to inflate. It therefore follows that a fiscal constitution implemented according to a practice will achieve lower inflation than a discretionary fiscal polity.For example, Judd and multi-colour (1991, 1992, 1993) and McCallum (1988) have examined the empirical gracefulties of nominal feedback sways and find that the expend of wide feedback rules could have produced price stability for the unite States over the past several decades without signifi cig bettly increasing the irritability of historic(a) output. 1 This subject examines whether the commutation vernacular of Taiwan would have had a more successful financial insurance insurance if it had followed an explicit rule rather than the discretionary policies it actually implemented.Of the rules considered here, solitary(prenominal) one yields some(prenominal) an output disagreement and an inflation variance appreciably lower than those actually receivedized by the Chinese economy. Hence this makeup concludes that the discretionary policies implemented by the primeval chamfer of Taiwan were very shutting to being best. Svensson (1998) divides proposed rules for financial constitution into two ample groups, factor rules and maneuvering rules. performer rules require that the ab headmaster swear adjust its insurance peter in playnt to recreations between the actual and desired appreciate of one or more inconstants being rear terminate by the fiscal authority.Examples of this type of rule argon those proposed by some(prenominal)(prenominal) Taylor (1993) and McCallum (1988). A rule that requires the Fed to deck up the federal official funds aim (its cats-pawal roleate of financial policy) whenever the reaping enjoin of nominal gross domestic product is unexpectedly senior luxuriously school (the ramble of issue of nominal GDP being the intent variab le) regardless of new(prenominal) teaching gettable to the Fed is an example of an official document rule. hardly because musical instrument rules do non use all schooling available to the fiscal authority, as shown by both Friedman (1975) and Svensson (1998), they argon inferior to pecuniary policy rules that do use all available information.If a monetary policy rule minimizes a specified spil shut upe do up plot of ground allowing the monetary authority to use all available information, then Svensson (1998) calls it a natesing rule. If the monetary authority is following a channelizeing rule, then it will respond to all information in a manner that minimizes its personnel casualty move. The loss theatrical role formalizes how of import the monetary authority believes ar asides of its diverse guide variables from their optimum set. The policy rule is derived from the optimal solution of the high-power programming problem that minimizes the loss role subj ect to the structure of the economy.The resulting rule expresses the g speechth of the policy instrument as a constituent of the mold variables in the bewilder. That is, the policy instrument responds non simply to the target variables that also to all other variables in the sample. Hence a targeting rule would not 2 always require the Fed to raise the federal funds value when the g pathth number of nominal GDP is unexpectedly high because other information might imply that the relatively high regulate of ripening of nominal GDP is the result of an increase in the reaping step of real GDP (rather than an increase in inflation).Although there appears to be a growing consensus that price stability should be the central long-run objective of monetary policy, there are still continuing debates about the proper selection of the policy instrument and the best target variables. But clearly the choice of the best policy instrument and the best target(s) is an empirical issue. Furthermore, the best choices can vary from country to country because the ascendencylability of any exceptional policy instrument and the effectiveness of each target most likely vary across countries.Therefore, this opus examines two different policy instruments and several targets to explore for the best policy rule for Taiwan. The rest of this publisher is organized as follows. Section 2 discusses the instrument and the targets of monetary policy that this paper considers. Section 3 describes the system employ to derive the policy rules and conduct the modelings. Section 4 describes the selective information and familiarizes the simulation results, while Section 5 offers some conclusions. 2. meanss and indicates of financial Policies In discussing how monetary policy should be implemented it is helpful to draw a istinction between the instruments and the targets of monetary policy. The targets of monetary policy are those macroeconomic variables that the monetary aut hority ultimately desires to influence through its policy actions [Friedman, 1975]. For this argue Svensson (1998) prefers to call target variables only those variables that are essential enough to be include in the monetary authoritys loss function. The targets of monetary policy therefore are a way to formalize the overall objectives of a monetary authority.On the other hand, the instrument of monetary policy is the variable that the monetary authority chooses to control for the usance of meeting its overall objectives, i. e. minimizing its loss function. 3 fiscal policy instruments basically fall into two categories: the monetary base and short-term affair place. Proponents of using the monetary base as the instrument of monetary policy argue that the base is the variable that determines the collect aim of prices, and therefore is a natural instrument for the control of inflation [McCallum (1988)].But most central coasts, including the central bank of Taiwan, use a short -term invade rate as their instrument of monetary policy. Proponents of an interest rate instrument point out that it insulates the economy against derangement in the demand for money, that interest rates are a part of the transmission channel of monetary policy, and that no useful purpose is served by all-encompassing fluctuations in interest rates [Kohn (1994)]. This paper plays simulation results using both types of instruments. The results support the central bank of Taiwans decision to use an interest rate instrument.This paper examines four target variables: a monetary aggregate, the convert rate, nominal income and the rate of inflation. 1 The targeting of a monetary aggregate often is advocated by those who believe that occupancy cycles intumescently result from adjustments in the growth rate of a monetary aggregate [Warburton (1966), M. Friedman (1960)]. Another close for choosing a monetary aggregate as the target variable for monetary policy is its ability to ser ve as a nominal anchor that can prevent policies from allowing inflation to increase to an unacceptable level.Although this allows a monetary aggregate to communicate long-run policy objectives to the world-wide familiar, as Friedman (1975) points out, it is by its very temper an inferior choice as a target variable because the monetary authority is only concerned with monetary aggregates to the extent that it provides them with information about inflation and output growth. 2 1 Recent For a more complete discussion about different target variables, con Mishkin (1999). That is, monetary aggregates are talk terms targets rather than true targets of monetary policy. Friedman (1975) shows that the use of mediate targets is not optimal. Although Svenssons (1998) idea of using forecasts of the target variable as a synthetic intermediate target is implicit in Friedmans (1975) discussion. 4 instability in the velocity of money for the time being has ended any possibility that a monet ary aggregate will be use as a target for monetary policy in the joined States. McKinnon (1984) and Williamson and Miller (1987) argue that monetary policy should target the give-and-take rate in an open economy.For example, the supercede rate has been the sole or main target in most of the EMS countries. Pegging the domestic currency to a strong currency prevents changes in the exchange rate from having an effect on the domestic price level. But exchange rate targeting results in the loss of an item-by-item monetary policy. The targeting country cannot respond to domestic shocks that are independent of those hitting the anchor country because exchange rate targeting requires that its interest rate be nigh linked to that in the anchor country.McCallum (1988) suggests a nominal GDP targeting rule because of its close relationship with the price level. The nominal GDP target has intrinsic draw when instability in velocity makes a monetary target unreliable. As long as the growth rate of real GDP is predictable, there is a predictable relationship between nominal GDP and the price level. However, recent studies on the time series properties of real GDP raise questions about the predictability of real GDP.If real GDP does not grow at a perpetual rate, then a constant growth rate for nominal GDP does not guarantee a stable price level. lately there has been a great upsurge of interest in cover inflation targeting, a policy that has been adopted by the central banks of New Zealand, Canada, the United Kingdom, Sweden, Finland, Australia, and Spain. Although this policy has been implemented with apparent success in the above countries, there are theoretical concerns with inflation targeting.One problem with inflation targeting is that the effect of monetary policy actions on the price level occurs with considerably more delay than its effects on financial variables. The use of a financial variable such as monetary aggregates or exchange rates as the target wou ld provide an earlier signal to the public that policy has deviated from its goals. In addition, starts by the central 5 banks to achieve a pre rigid path for prices may cause large movements in real GDP, except only if the price level is sticky in the short run.But the apparent success of inflation targeting, where it has been essay, suggests that these concerns are misplaced. 3 Also, because the effect of monetary policy on long-term trends in output and employment is directly considered to be negligible, many economists are now advocating that monetary authorities should use only inflation (or the price level) as the sole target for monetary policy. agree to this view the main contribution that monetary policy can make to the trend in real output is to create an environment where markets are not distorted by high and volatile inflation.The central bank of Taiwan appears to have accepted this position. It has repeatedly stated that its number one priority is price stability and the reaction function imaged by Shen and Hakes (1995) confirms that it has behaved as if price stability is an important policy goal. So what combination of policy instrument and target variable would result in the best rule for monetary policy in Taiwan? Would the adoption of such a rule have improved Formosan monetary policy during the past three decades?To answer these questions this paper experiments over two policy instruments (monetary base and interest rate) and four target variables (the rate of inflation, the growth rate of nominal GDP, the growth rate of the monetary base, and the change in exchange rate) in an attempt to find what would have been the best targeting rule for Taiwan during the period 1971:1-1997:4. The diachronic performance of the Taiwanese economy is then compared with the performance predicted by the â€Å"best” targeting rule to evaluate how good Taiwanese monetary policy has been.This comparison is made by comparing the volatility of th e relevant variables resulting from the proposed rules with those from the historical data. 3 A attentive reading of Friedman (1975) and Svensson (1998) also suggests that these concerns are misplaced. 6 Although, as noted above, by their very nature targeting rules are superior to instrument rules. Hence this paper emphasizes targeting rules. But just how much better targeting rules are than instrument rules is an empirical question of some practical vastness because instrument rules are more transparent than targeting rules.Hence, for completeness, this paper also presents results for instrument rules using the rate of interest and the monetary base as instruments and the rate of inflation as the target variable. 3. The Model and Methodology 3. 1 The instrument rule An instrument rule adjusts the growth of the policy instrument in answer to asides between the actual and desired grade of the target variable. That is, ? It = ?? (? xt-1 †? xt-1*), (1) where It represents th e policy instrument, ? xt is the target variable, the superscript * denotes the target value desired by the central bank, and ? efines the proportion of a target miss to which the central bank chooses to respond. In this paper, variables are expressed as deviations from their own means. Therefore, there is no cost in terms of inductive reasoning to repose the targeted growth rate desired by the central bank to zero. The economy is characterized by an open-economy VARX model which includes five variables: the growth rate4 of real income (? yt), the rate of inflation (? pt), the change in the logarithm of the exchange rate (? et), the growth rate of the monetary base (? mt), and the change in the interest rate (? rt).Since the purpose of this paper only requires a model that fits the Taiwanese economy well during the sample period, we use a ecumenic VARX model with a 4 Growth rates in the empirical work are work out by taking log-first differences. 7 maximum lag continuance of fo ur and adopt Hsiao’s (1981) method to determine the optimal lags for each variable. 5 Specifically, the general VARX model can be written as: ? Xt = A0 + A1? Xt-1 + A2? Xt-2 + A3? Xt-3 + A4? Xt-4 + i =0 ? ai ? I t ? i 4 + ? t, (2) where ? Xt is the 4? 1 transmitter that contains variables other than the growth of the policy instrument.The policy instrument has immediate effects on other variables if the 4? 1 vector a0 is not zero. For example, if the instrument is rt and the target is ? pt, then Xt = [ yt, pt, et, mt ] and equations (1) and (2) can be written as: ? rt = ? ?pt-1, ? Xt = A0 + A1? Xt-1 + A2? Xt-2 + A3? Xt-3 + A4? Xt-4 + (1)’ i =0 ? ai ? rt ? i 4 + ? t. (2)’ Previous studies such as Judd and alter (1991, 1992, 1993) and McCallum (1988) estimate equation (2) and assume that the economy instances the same set of shocks that actually occurred in the sample period.The estimated equation, the historical shocks, and the policy rule (1) are used to brin g the counterfactual data. Statistics calculated from the counterfactual data are then compared to the historical experiences. In these studies, the response parameter ? is indiscriminately set and the results from different ? ’s are compared. However, condition linearity of the model and the variance-covariance hyaloplasm of historical shocks, one can analytically solve for the value of ? that minimizes the variance of the inflation rates. Specifically, substituting (1) into (2) yields a VAR(5) in ?Xt. For convenience, the VAR(5) system can be written as a more compact expression: 5 We tried to adopt Balls (1998) open-economy Keynesian type model to Taiwan, but this model was not supported by the Taiwanese data. 8 ?Wt = B0 + B1? Wt-1 + ? t, (3) where Wt = [ Xt, Xt-1, Xt-2, Xt-3, Xt-4 ] and ? t = [? t, 0] are both 20? 1. Assume that ? Wt is stationary. Denote V? W as the variance-covariance matrix of ? Wt and V? the variance-covariance matrix of ?t. Equation (3) implies V? W = B1 V? W B1′ + V?. (4) apt(p) the regression results of (2), the variance of ? t is a function of ? only. Therefore, the value of ? that minimizes the variance of ? pt, given(p) historical shocks, can be calculated. The advantages of an instrument rule include its simplicity, hydrofoil to the public, and the fact that it is always operational. The central bank responds to discovered deviations from the target and does not need to base its policy actions on forecasts that require fellowship of the structure of the economy. However, as noted above, instrument rules are not optimal in the sense that they do not use all available information.The policy instrument only responds to the target variables, which is normally inefficient compared to rules that allow the instrument to respond to all the variables in the model. The following section uses an optimal control problem to derive the optimal policy rule, instead of specifying the rule in advance. 3. 2 The targeting rule A targeting rule is derived from the minimization of a loss function. This loss function reflects the policymaker’s desired path for the target variable. A commonly used one is a quadratic loss function which penalizes deviations of the target variable from its target value.The policymaker’s optimisation problem can be lick with the knowledge of the dynamics of the economic structure, which is equation (2). That is, equation (2) is used as the constraints in the dynamic programming problem. To simplify analysis, equation (2) is written as a first- exhibition system, Zt = b + B Zt-1 + C ? It + ? t, (5) 9 where Zt = [? Xt, ? Xt-1, ? Xt-2, ? Xt-3, ? It, ? It-1, ? It-2, ? It-3]. The constant vector b is 20? 1, B is 20? 20, C is 20? 1, ? t is 20? 1, and their arguments should be obvious. Therefore, the central banks control problem is to minimize a menstruation of expected quadratic loss function: T 1 E0 ?Zt ‘ K Zt, T t =1 (6) subject to Zt = b + B Zt-1 + C ? It + ? t, (5) where the mind-set E0 is conditional on the initial condition Z0. Again, without loss of generality, the target value is set to zero since all the variables are expressed as deviations from mean. The fragments in the matrix K are weights that represent how important to the central bank are deviations of the target variables from their target values. For example, if the central bank wants to target the inflation rates, then the [2,2] element of K is 1 and the other elements are all zeros.The loss function is equivalent to (1/T) E0 ?t =1? pt 2 . T If the central bank wants to target the nominal GDP, then the 2? 2 block on the upper left loge of K is a unity matrix and the other elements are all zeros. The loss function in this racing shell is (1/T) E0 ?t =1(? yt + ? pt ) 2 . T instanter the problem is to choose the policy instrument ? I1, . . . , ? IT that minimizes (6), given the initial condition Z0. By using Bellmans (1957) method of dynamic programming the problem is solved backward. That is, the last period T is solved first, given the initial condition ZT-1.Having found the optimal IT, we solve the two-period problem for the last two periods by choosing the optimal IT-1, contingent on the initial condition ZT-2, and so on. Letting T > ? , the optimal policy rule can be expressed as [see cream puff (1975, ch. 8) for derivation details]: ? It = G Zt-1 + f , with (7) 10 G = -(C ‘ HC) ? 1 (C ‘ HB), f = -(C ‘ HC) ?1 C ‘ (Hb-h), H = K + (B+CG) ‘ H (B+CG), and h =[I-(B+CG) ‘ ] ?1 [- (B+CG) ‘ Hb]. The rule defines the policy instrument as a function of the predetermined variables in the model. The economy is assumed to face the same set of shocks that actually occurred in the historical period.Therefore, the estimated equations, the policy rule, and the historical shocks are used to generate the counterfactual data. The resulting statistics are compared. Even though it is usually more efficient to let the in strument respond to all the relevant variables than to let it respond only to the target variables, the ad hoc instrument rules are more widely discussed in the literature. The reason for the preference for simple instrument rules may be that the targeting rule is more sensitive to model preconditions. For example, the assumption of full information is generally maintained for the computation of an optimal rule.This tends to make the targeting rule less robust to model specification errors than are the simple instrument rules. In addition, the optimal rule may require larger adjustments of the instrument because it responds to more variables. This would in turn yield unsought higher volatility of the other variables such as output growth. Therefore, again, the choice between the instrument rule and the targeting rule cannot be determined by theory alone and is an empirical issue. 4. Empirical Results 4. 1 info This paper uses Taiwanese national quarterly time series data for the period 1971:11997:4.The sample starts in 1971:1 because of data availability. both data are taken from two databanks: the depicted object Income Accounts Quarterly and the financial Statistical Databank. 11 The rediscount rate is used as rt because it indicates the policy intentions of the central Bank of Taiwan most directly. The monetary base mt is defined as the reserve money. The exchange rate target is the NT/US dollar rate. The variable yt is real GDP in millions of 1991 NT dollars, and pt is defined as the GDP deflators. object interest rates, all variables are in logarithms. All variables are in first-difference form and expressed as deviations from their means.The Augmented Dickey-Fuller (ADF) test is used to ensure that the variables are transformed into stationary processes6. The top row of tabularize 1 presents the historical regularised deviations of the variables in the model in order to allow comparison with the values obtained from the simulations. 4. 2 Estima tion results under instrument rules impanel A in Table 1 presents the normal deviations obtained using an instrument rule with inflation as the target variable. The first row of Panel A presents simulation results under an interest rate instrument, while the second row presents results under a monetary base instrument.The simulations using an interest rate instrument yielded standard deviations for output growth, the change in the exchange rate, and money growth that are only some higher than those for the historical data, while the standard deviation of inflation is pretty lower than its historical value. The only standard deviation in the first row of Panel A that differs substantially from the historical data is that for the change in the interest rate, which is much lower in the simulation.These results indicate that actual policy in Taiwan achieved results almost as good as those that would have been obtained under an optimal interest-rate instrument rule with the 6 The lag lengths in the ADF regressions are determined by the Akaike Information Criterion (AIC) and the Schwartzs (1978) criterion. The maximum length is set to 12. A time trend is included in the yt, pt, and mt regressions. All results indicate that the original time series are integrated of order one. The results of the tests are available from the authors upon request. 12 xception that the optimal rule would have yielded a more stable rate of interest. The simulation using the monetary base as the instrument yielded slightly higher standard deviations for all variables except the rate of inflation. Those for output growth, the change in the exchange rate, and the rate of interest were only slightly higher than the historical values, while the standard deviation of the growth rate of the monetary base was much higher than its historical value. The standard deviation of the inflation rate is slightly lower than the historical value but is higher than that in the interest rate instrument ru le.These results suggest that the discretionary policy implemented in Taiwan was superior to an optimal monetary base instrument rule. They also indicate that an instrument rule using the rate of interest would have been superior to one employing the monetary base as instrument, though not by a large margin. 4. 3 Estimation results under targeting rules Panel B of Table 1 presents standard deviations of the variables under the various targeting rules considered here. The first four rows of Panel B present results obtained using an interest rate instrument.In the first row of Panel B the standard deviation of nominal GDP is minimized; in the second row the standard deviation of inflation is minimized; and so on The last three rows of Panel B present results under a monetary base instrument. signalise that for both instruments, if nominal GDP is the target, then the standard deviations of all variables are higher than their historical values. This implies that the growth rate of nom inal GDP would not have been a suitable target variable for Taiwan. Furthermore, brand that for all targets under the monetary base instrument the standard deviation of output growth is much higher than its historical value.This effectively rules out status of the monetary base as the instrument of monetary policy under a targeting rule for Taiwan. Now notice from the fourth row of Panel B that if the monetary base is the target under an interest rate instrument, the standard deviations of output growth and inflation are both higher 13 than their historical values. This effectively rules out the use of the monetary base as an appropriate target for monetary policy in Taiwan. Finally, by comparing rows â€Å"? pt designate” and â€Å"? t Target” of Panel B, one sees that if the rate of inflation is the target, then the standard deviations of output growth and inflation are lower than if the exchange rate is the target. Also, if inflation is the target, the standard d eviations from the simulations for inflation and output are lower than their historical values. Hence it is concluded that Taiwanese monetary policy would have been better than its historical performance if it had used an optimal targeting rule with the rate of interest as instrument and inflation as the target. 5. Conclusion Taiwan has been very successful in using discretionary monetary policies.This paper attempts to see whether there exist policy rules that can improve the Taiwanese economy for the past several decades. This paper evaluates several monetary policy rules using Taiwanese quarterly data from 1971:1 to 1997:4. Two types of policy rules are examined. agent rules adjust the growth of the policy instrument in response to deviations between the actual and desired values of the target variable. Unlike those in the previous studies where arbitrary instrument rules are proposed, this paper solves analytically for the optimal instrument rules that minimize the standard dev iation of the rate of inflation.Targeting rules are derived from the solution to the dynamic programming problem that minimizes a loss function subject to the structure of the economy. The rule expresses the growth of the policy instrument as a function of all the predetermined variables in the model. Two policy instruments (interest rate and monetary base) and four targets variables (nominal GDP growth, inflation rate, changes in exchange rates, and money growth rate) are examined in the paper. Simulations of a simple VARX model and the policy rules suggest that, 14 ompared to the historical policy, the use of a policy rule in Taiwan would not have reduced substantially the volatility of inflation rate. The only policy rule that would appeal to the authority is the direct inflation targeting rule with the interest rate as the instrument. This rule would have reduced the standard deviation of the inflation rate in Taiwan by 0. 7% while maintained similar volatility of the other vari ables to those in the historical data. 15 References Ball, L. (1998), â€Å"Policy Rules for Open Economies,” NBER Working Paper 6760. Barro, Robert J. (1986). Recent Developments in the Theory of Rules Versus Discretion,” The Economic journal Supplement, 23-37. Bellman, R. E. (1957), Dynamic programming, Princeton, N. J. : Princeton University Press. Chow, G. C. (1975), summary and Control of Dynamic Economic System, John Wiley & Sons Press. Friedman, gum benzoin (1975), â€Å"Rules Targets, and Indicators of financial Policy,” Journal of Monetary Economics, 1, 443-73. Friedman, Milton (1960), A Program for Monetary Stability. Fordham University Press, New York. Hsiao, C. (1981), â€Å"Autoregressive modelling and money-income causality detection,” Journal of Monetary Economics, 7, 85-106.Judd, J. P. and B. Motley (1991), â€Å"Nominal feedback rules for monetary policy,” federal halt Bank of San Francisco Economic Review (Summer), 3-17. Judd, J. P. and B. Motley (1992), â€Å"Controlling inflation with an interest rate instrument,” national Reserve Bank of San Francisco Economic Review 3, 3-22. Judd, J. P. and B. Motley (1993), â€Å"Using a nominal GDP rule to guide discretionary monetary policy,” Federal Reserve Bank of San Francisco Economic Review 3, 3-11. Kohn, D. L. (1994), â€Å"Monetary aggregates targeting in a low-Inflation economyâ€Discussion,” in J. C.Fuhrer, ed. , Goals, Guidelines, and Constraints Facing Monetary Policymakers, 130135. Federal Reserve Bank of Boston. Kydland, F. E. and Prescott, E. C. (1977), â€Å"Rule rather than discretion: The inconsistency of optimal plans,” Journal of political Economy 85, 473-491. McCallum, B. T. (1988), â€Å"Robustness properties of a rule for monetary policy,” CarnegieRochester Conference Series on Public Policy 29, 173-204. 16 McKinnon, Ronald (1984). An International archetype for Monetary Stabilization, chapiter: nominate for International Economics. Mishkin, F. S. (1999). International experiences with different monetary policy regimes,” NBER Working Paper #6965. Schwartz, S. G. (1978), â€Å"Estimating the Dimension of a Model,” Annals of Statistics 6:461-464. Svensson, Lars E. O. (1998), â€Å"Inflation Targeting as a Monetary Policy Rule,” NBER Working Paper #6790. Shen, C. H. and Hakes, D. R. (1995), â€Å"Monetary policy as a decision-making hierarchy: The case of Taiwan,” Journal of Macroeconomics 17, 357-368. Taylor, John B. (1993). â€Å"Discretion versus Policy Rules in Practice,” Carnegie-Rochester Conference Series on Public Policy, 39: 195:214.Warburton, Clark (1966), â€Å"Introduction,” Depression, inflation, and Monetary Policy: Selected Papers, 1945-1953. Johns Hopkins Press, Baltimore. Williamson, John and Miller, Marcus (1987). Targets and Indicators, Washington: Institute for International Economics. 17 Table 1:Standard Deviations of the Variables (in Percentage) Output Growth ? yt Historical Data: false Data: (A) Instrument Rules: Interest Rate Instrument: ? pt Target Monetary tail Instrument: ? pt Target (B) Targeting Rules: Interest Rate Instrument: ? (yt + pt) Target ? pt Target ? et Target ? t Target Monetary Base Instrument: ? (yt + pt) Target ? pt Target ? et Target 5. 346 3. 862 3. 798 4. 964 1. 972 3. 449 2. 767 5. 950 2. 139 14. 63 27. 781 6. 794 0. 185 0. 198 0. 159 4. 348 2. 993 3. 047 4. 446 4. 314 2. 092 3. 064 6. 880 3. 076 2. 469 2. 361 2. 771 5. 421 4. 473 4. 281 4. 058 0. 485 0. clxxv 0. 332 0. 431 -2. 38 3. 308 2. 748 2. 718 6. 540 0. 178 3. 185 Inflation Rate ? pt 2. 793 transmit in Exchange rate ? et 2. 415 Monetary Base Growth ? mt 4. 315 Change in interest rate ? rt 0. 162 Optimal ? : 0. 0133 3. 201 2. 633 2. 601 4. 454 0. 035The sample period is from 1971:1 to 1997:4. The variable ? yt is real GDP growth rate, ? pt is inflation rate, ? et is change in exchange rates, ? mt is monetar y base growth rate, and ? rt is change in interest rates. All data are from the National Income Accounts Quarterly and the Financial Statistical Databank data banks. The response parameter ? in the instrument rules defines the proportion of a target miss to which the central bank chooses to respond. 18 Figure 1 Inflation Rate (annual rate %) 70 60 Inflation Rate (% per year) 50 40 30 20 10 0 -10 70 74 78 82 twelvemonth 86 90 94 98 19\r\n'