By Nicoletta Batini, Richard Harrison and Stephen P Millard
The literature on simple rules for monetary policy is vast. However, the literature does not contain a thorough normative analysis of simple rules for open economies, ie for economies where the exchange rate channel of monetary policy plays an important role in the transmission mechanism. The most popular simple rule for the interest rate—the ‘Taylor rule’—for example, was designed for the United States and, thus, on the assumption that the exchange rate channel is less important. And the main open-economy alternatives— such as a rule based on a monetary conditions index (MCI)—may perform poorly in the face of specific types of exchange rate shocks.