In this paper, we explore McCallum's monetary base instrument rule in the context of several models. The first section uses two models, previously utilized by McCallum, to demonstrate the general properties of his rule and to update through 1992 the empirical support for the rule. The second section uses models that allow a significant role for interest rates in transmitting the effects of changes in the monetary base to aggregate demand. The analysis in these two sections makes two main points: (1) Shifts. or instabilities, in the structural relationship between the base and nominal GNP in the 1980s and 1990s raise questions about the efficacy of the proposed rule; and (2) The ability of McCallum's base instrument rule to control nominal output depends on the response pattern of the target variable, nominal output, to changes in the base. In the sequence of models presented, we lay out these dynamic linkages in successively more detail and examine their ·implications for nominal income targeting.
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Hess, Gregory, Small, David, and Flynt Brayton. "Nominal Income Targeting with the Monetary Base as Instrument: An Evaluation of McCallum's Rule," in Operating Procedures and the Conduct of Monetary Policy: Conference Proceedings, edited by Marvin Goodfriend and David Small, Finance and Economics Discussion Series Working Study 1, Volume 2, Federal Reserve Board, Washington, DC, 1993