OPTIMAL MONETARY-POLICY - A NEW TEST

Tests of the optimality (given some well-specified criterion) of actual monetary policy are scarce in the macro literature. The purpose of this paper is twofold: first to examine how the nature of economic shocks (that is, their type, frequency, persistence, etc.) determines the optimal degree and sign of cyclical activism; and second, to test whether actual monetary policy has satisfied a simple optimality criterion. The criterion states that if policy is motivated by price and output stability objectives, it ought to react countercyclically to transitory shocks under the presumption that transitory shocks are mostly of demand origin; and procyclically toward past persistent supply disturbances. We subject this contention to a test in the United States, Canada and the United Kingdom by using a variety of measures of disturbances (the Blanchard-Quah, the Solow-Prescott residuals, as well as oil price shocks) and the monetary base and the federal funds rate as monetary policy instruments. The empirical evidence failed to uncover any systematic pattern in actual policy that would be consistent with the suggested criterion.