Rule-based Monetary Policy for Developing Countries, Evidence from Developed Countries

Abstract: Price and output stabilities determine the success of monetary policy in either economy. This paper briefly examines the monetary policy strategies of three developed countries (USA, UK, Sweden) and three developing countries (Bangladesh, India, Pakistan). It is found that the developed countries follow some rule-based monetary policy whereas the developing countries with ill-organised monetary system do not follow the rule-based policy, rather they often formulate and launch policies under some discretionary framework. The fundamental objective of this study is to examine the performance of rule-based monetary policy in developing countries by extracting experience from developed ones. Since its inception in 1993, Taylor rule has become synonymous to monetary policy. But it is a matter of fact that this rule was grounded on the developed economies and numerous researches have been carried out with the same respect disregarding the applicability of this rule to the developing economies. In this paper, I use one simple macroeconomic model to simulate the economies with the Taylor rule as monetary policy. Counterfactual simulation confirms that macroeconomic performance of developing economies can be improved, in terms of stability in inflation and output, when simple Taylor type rule is followed and it further improves the performance with some degree of smoothing in the instrument. Using data for the period 1984-2008, this study proposes a set of optimal parameter values for Taylor rule and coefficients of lagged interest rate for different countries.