INFORMATION LAGS AND THE INTEREST RATE AS A PROXIMATE MONETARY POLICY TARGET
| Published date | 01 May 1975 |
| Date | 01 May 1975 |
| DOI | http://doi.org/10.1111/j.1468-0084.1975.mp37002003.x |
| Author | ROGER N. WAUD |
INFORMATION LAGS AND THE INTEREST RATE
AS A PROXIMATE MONETARY POLICY TARGET
By ROGER N. WAUD*
An argument often advanced in favour of the monetary authority focusing on a
proximate target such as the interest rate, instead of an ultimate goal variable
such as the income level, is that information about the values of proximate target
variables is more current than that available about ultimate target or goal vari-
ables.1 The main purpose of this paper is to examine the validity of this argument.
Specifically, we will ask whether in an uncertain world the variance around the
income level, the ultimate target variable, can always be reduced by focusing on a
proximate target variable, such as the interest rate, whose most recent value is
known with a shorter lag than that associated with the most recently known value
of the income level.
In Section I the assumptions and analytical framework to be used are laid out.
In Section II we carry out the actual analysis. Our overall conclusion, stated in
Section III, is that given the performance criterion used here it is not necessarily
true that a proximate target interest rate policy predicated on more current informa-
tion is superior to an ultimate target income policy. It all depends on the parameter
values of the system.
I. ASSUMPTIONS AND ANALYTICAL FRAMEWORK
Several assumptions will be maintained in the course of the following analysis.
Some of them effectively characterize the monetary authority as more knowledge-
able than is realistic. This is helpful, however, in that it allows us to focus on our
principal inquiry without the obfuscations of other real-world complications.
Whatever difficulties the monetary authority encounters in the framework to be
outlined here, they would in all likelihood only be further exacerbated by further
deference to reality.
It will be assumed that the monetary authority takes the ultimate goal of
policy to be the minimization of the variance of real income about some desired
real income level. Other goals, and indeed more than one goal, are often espoused,
but this one is typically attended by a large audience of interest among both
policymakers and academic economists. The quadratic criterion function is
probably the most familiar and certainly among the most analytically tractable-
recommendations admittedly supported largely by the questionable reed of
convenience.
It will be assumed that the monetary authority has a more current knowledge
of the value of the interest rate than it does of the income level. This indeed is
perhaps the most often alleged reason for using the interest rate as a proximate
* I would like to thank David Pierce and Steve Salop for helpful discussion on this topic
and Evelyn Flynn for computer assistance. Responsibility for any errors is of course mine.
1For an extensive list of references on the subject of proximate targets see Waud (1973).
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