The Monetary Transmission Mechanism and the Evaluation of Monetary Policy Rules

2The purpose of this paper is to explore the connection between the monetary transmission mechanism—the channel through which a change in monetary policy affects the economy—and the choice of monetary policy rules to guide central bank decisions. Different views of the monetary transmission mechanism are readily apparent in the many different models that monetary economists use to evaluate monetary policy. For example, a symposium on "The Monetary Transmission Mechanism " in the fall of 1995 (Journal of Economic Perspectives, Vol. 9, No. 4, pp. 3-72) contains five papers representing alternative views. The question is: Do these different views lead to substantial differences in the optimal rules for monetary policy? In order to answer this question, I draw on evidence obtained in recent and ongoing research on the quantitative evaluation of monetary policy rules. In fact, there has been an explosion of this type of normative macroeconomic research in recent years, reflecting both an increase in supply by researchers and an increase in demand by policy makers. Most of the new normative macroeconomics takes as given that the central bank has an explicit or implicit inflation target, and this assumption immediately makes the research useful to many central bankers. The purpose of the research is then to find policy rules to guide policy makers i