Monetary policy objectives and economic outcomes: What can we learn from a wavelet‐based optimal control approach?

Abstract

It has recently been widely recognized that monetary policy objectives change through time as our understanding of monetary policy and its impact on the macroeconomy evolves. In recent years there has been an extensive review of the framework for monetary policy at major central banks around the world, given the practical problems that have been encountered with inflation targets. This paper is a contribution to this debate, in that the aim of this paper is to evaluate the consequences of adopting different monetary policy objectives in the U.S. macroeconomic policy setting. To accomplish this, we first decompose U.S. macroeconomic data using a time‐frequency domain technique, namely discrete wavelet analysis. We then model the behavior of the U.S. economy over each wavelet frequency range and use our estimated parameters to construct a tracking model. To illustrate the usefulness of this approach, we simulate jointly optimal fiscal and monetary policy with different short‐term monetary targets: an inflation target, a money growth target, an interest rate target, and a real economic growth target. The results show that the most effective monetary policy targets to achieve economic growth are either inflation targets or economic growth targets.

Do the interest rates really relate to economic growth? The case of Greece

“…Their results indicate that the causal relationship in short and medium run is unidirectional and bidirectional in the long run. Crowley and Hudgins [13] using a discrete wavelet analysis indicate that monetary policy is more effective on economic growth when it targets inflation or economic growth. Examining the transmission channels of monetary policy in the US, Odo and Bosniak [14] conclude that during periods of financial uncertainty, investment and bank lending channels are the most effective.…”