27 thepolicybetween20022005isdefinedas

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Unformatted text preview: Borrowed Reserves 22 Targeting Interbank Rate 23 Criteria For Choosing Policy Instrument Observability and measurability Interest rates are more observable and easily measurable than monetary aggregates. However; it is the nominal interest rates that we observe and it is a poor measure of the actual cost of borrowing i.e. the real interest rate. The real interest rate is not observable. (ir = i­ Πe) ► Controllability: CB must be able to exercise effective control over the variable. Monetary aggregates are harder to control due to shifts in and out of currency. It is easier to control the short term interest rate (nominal). However the CB can not set the real interest rate. ► Predictable Effect on Goals: In recent years it is believed that the link between interest rates and inflation is tighter than monetary aggregates and inflation. Conclusion: CB’s throughout the world use short­term interest 24 rates as their policy instrument. ► Taylor Rule How should the target of short­term interest rates be chosen? Prof. John Taylor, suggested a simple equation that t...
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