Introduction

Monetary policy plays a significant role in developing the economy. This paper examines different aspects of the monetary policy that have been used in different countries to develop the economy in positive manner. Over the past decades, developed countries have changed the interest rates and money supply that are the tools of monetary policy so that they can check the pros and cones of these policies on the economy. Inflation targeting is another aspect of monetary policy that is adopted widely by the developed countries in their economy. This paper analyzes the past changes that have been made in the monetary policy and its tools as it is applied in developed economies to achieve positive economic results. The econometric strategy analysis investigation on monetary policy has also been discussed in the paper. The paper has given much attention to evaluate the use of inflation targeting as a tool to check the results of monetary policy on the economy.

Discussion

The central point of the paper is discussing the tools that can ultimately stabilize the real output in the economy by adopting the strategies of targeting inflation and nominal interest rates in the economy. As the paper proposes the monetary policy that can augment real interest rate and inflation in the economy to give rise to the real GDP in the economy, the Taylor's rule holds a significant place in the application of this policy. Writing in 1993, John B. Taylor proposed a theory for the monetary authorities to apply a policy rule that would help to stabilize real output around a target and control inflation. Their policy rule is based on a nominal interest rate, when real GDP and the inflation rate exceeds its target, increases to generate an increase in real interest rates and reduce aggregate demand(Taylor, 2005, Pp 28).

Conversely, if inflation and real GDP falls below the target, it is recommended to cut the nominal interest rate so that aggregate demand can be increased by means of an increase in real interest rate. Thus, according to Taylor, the short term nominal interest rate should be an increasing function of inflation and real output for given objectives in both variables. The paper also discusses some issues related to the effectiveness of interest rate rules in achieving goals by the government and highlights several theoretical and practical issues that restrain the outcomes. The paper includes a brief discussion of the theoretical framework that has been used to evaluate the performance of the policy rule and then focuses on the issues considered most important for this stabilization policy rule (Walsh, 2005, Pp 25).

As it is known by the subject, the Keynesian models designed to evaluate the performance of the Taylor rule set consists of equations for aggregate demand and inflation, the term structure of interest rates and the rule of interest rate policy that connects the interest rate on short-term deviations of inflation and real output of its goals. The role of aggregate demand is a function that takes the form ...