Difference Between Monetary Targeting, Inflation Targeting and Taylor Rul Essay

Difference between monetary targeting, inflation targeting and Taylor rule. In which case is money demand exogenous and in which case endogenous? Monetary targeting Monetary targeting is a strategy that uses monetary aggregates as an intermediate to achieve an ultimate goal such as price stability. In other words the amount of money in circulation is controlled by the central bank to achieve price stability or a stable inflation rates. From a neoclassical point of view, this is the best monetary strategy. In theory (i. e. according to the neoclassical paradigm), money demand is exogenous for monetary targeting.

However, Keynesians argue that this is not true. Accordingly, they claim money demand is endogenous (i. e. determined within the model). Furthermore, Keynesians criticise that monetary targeting can lead to fluctuation of interest rates which then lead to price instability. Today, hardly any central bank follows this strategy anymore. Inflation targeting Inflation targeting is an economic policy in which the central bank estimates and makes public a projected or “target” inflation rate and then attempts to steer actual inflation towards the target.

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To reach the target it can adjust the interest rate or use other monetary tools (I wasn’t sure what exactly they are). So the goal of this strategy is to reach a positive, modest inflation rate. The inflation target should be positive because if the inflation rate is too close to 0, there might be a danger of deflation which is much worse than inflation. This strategy became popular in 1990’s after monetary targeting failed. For advocates of the neoclassical paradigm, this is the second best monetary policy. Today it is used by most central banks (e. . ECB).

Money supply is endogenous. Taylor rule This refers to the monetary policy rule followed by some central banks like the US Federal Reserve, which stipulates how much the central bank would or should change the nominal interest rates in response to divergence from the target inflation rates and the actual GDP from potential GDP. In other words, the Taylor rule is like similar to inflation targeting, but also focuses on GDP growth. For Keynesians this is the most favourable monetary strategy. Money supply is endogenous.