Goals and Rules in Central Bank Design∗

Beginning with the Reserve Bank of New Zealand Act of 1989, central banking reforms have focused on assigning clear goals for which monetary policy authorities can be held accountable. Inflation targeting regimes provide examples of such goal-based policy frameworks. An alternative approach, recently argued for by John Taylor (2012, 2014), relies on a rule-based framework in which the policy authorities are judged on whether they set their instrument in a manner consist with a legislated rule. I consider the performance of goal-based and rule-based frameworks. I first show analytically that both goal-based and rule-based systems balance a tradeoff between reducing sources of policy distortions and preserving policy flexibility. Then, using an estimated DSGE model, I find the optimal weights to place on goal-based and rule-based performance measures. When the rule is similar to that proposed recently in U.S. H.R. 5108, I find the optimal weight to assign to the rule-based performance measure is zero. However, when the rule is based on the output effi ciency gap, it is generally optimal to make deviations from the rule a part of the central bank’s performance measure. JEL classification: E52, E61 ∗Prepared for the Reserve Bank of New Zealand and International Journal of Central Banking Conference “Reflections on 25 years of Inflation Targeting,”Wellington, NZ, Dec. 1-2, 2014. I would like to thank conference participants and seminar participants at Norges Bank for their comments and suggestions. Contact: University of California, Santa Cruz. email: [email protected].