Monetary targeting (MT) is a simple rule for monetary policy according to which the central bank manages monetary aggregates as operating and/or intermediate target to influence the ultimate objective, price stability. Under MT, the inflation target is not announced and the central bank intervention is concentrated only on the money market. Typically, the central bank sets the interest rates to control monetary aggregates, which are considered the main determinants of inflation in the long run. Thus, controlling monetary aggregates would be equivalent to stabilising the inflation rate around the target value.
The rationale of the MT lies in the Quantity Theory of Money described by the famous equation:
- Mt is the nominal money supply;
- Vt is the velocity of circulation of the money;
- Pt is the price level;
- Yt is the aggregate output.
Taking the logs and differentiating w.r.t. the time yields:
- is the money growth target;
- is the target in terms of inflation rate;
- is the potential output growth rate;
- is the percent change in the velocity of money;
Equation (2) identifies the money growth target (intermediate target) compatible with the goal target (). Hence, the central bank manages the interest rate in order to keep the actual money supply in line with the target according to the following equation:
Editor: Lorenzo CARBONARI
© 2009 ASSONEBB