Review: Recent Developments in the Analysis of Monetary Policy Rules

Bennett T. McCallum

The paper “ Recent Developments in the Analysis of Monetary Policy Rules” is based on the
Homer Jones Memorial Lecture, 1999, by Bennett.T.McCallum. The author traces the historical
evolution of monetary policy analysis from 1973-98. He then explains the macroeconomic
framework (with algebric representation) developed in the recent years for monetary policy
analysis and his own contributions to the field of monetary policy analysis.

The author chooses 1973 as the starting point of analysis because it signifies a sharp break in both
academic analysis and in real world monetary institutions. In other words, 1971-73 signifies the
collapse of the Bretton-Woods exchange rate system as well as the collapse of the new par values
established at the Smithsonian institution in 1971. Academically, the year 1971-73 saw the rise of
the Rational Expectation Hypothesis(REH). The author tries to explain the criticisms of REH,
which came because of its policy ineffectiveness proposition. However, the contention of REH
was not to disclaim monetary policy but to call for more sophisticated tools of monetary analysis.
Further, there was also an upsurge in Real Business Cycle analysis which aslo did not give much
importance to the role played by monetary policy in influencing real economic variables.
However, these developments did give rise to new empirical tools used to construct, estimate,
simulate monetary models in which economic actors are depicted as solving dynamic
optimisation problems and then interacting in competitive markets, but with some form of
nominal wage stickiness built into the structure. The attempt was to develop a model that is truly
structural, immune to Lucas critique, and appropriate for policy analysis.

The standard framework is a quantitative macroeconomic model that includes three main
components:
 An IS-type relation that specifies how interest-rate movements affect aggregate demand and
output
 A price adjustment equation that specifies how inflation behaves in response to the output
gap and to expectations regarding future inflation; and
 A monetary policy rule that specifies each period’s settings of an interest rate instrument.