Nominal GDP Targeting and the Taylor Rule on an Even Playing Field

Standard monetary policy analysis built upon the New Keynesian model suggests that an optimal monetary policy rule is one which minimizes a weighted sum of the variance of inflation and the variance of the output gap. As one might expect, the Taylor rule evaluates well under this criteria. Recent calls for nominal GDP targeting therefore must contend with Taylor rule as an alternative approach to monetary policy. In this paper, we argue that the information requirements placed on a central bank by requiring policymakers to have real-time knowledge of the output gap need to be taken into account when evaluating alternative monetary policy rules. To evaluate the relevance of these informational restrictions, we estimate the parameters of an otherwise standard New Keynesian model with the exception that we assume the central bank has to forecast the output gap using lagged information. We then use the model to simulate data under different monetary policy rules. The monetary policy rule that performs best is the nominal GDP targeting rule. ∗Western Kentucky University, Department of Economics, 423 Grise Hall, Bowling Green, KY 42101 [email protected] †Joshua R. Hendrickson: University of Mississippi, Department of Economics, 229 North Hall, University, MS, 38677 [email protected]