McCallum Rule

What Is the McCallum Rule?

The McCallum Rule is a monetary policy rule developed by economist Bennett T. McCallum toward the finish of the 20th century. The McCallum Rule utilizes a formula to set an operating target level for the monetary base in the next quarter based on the recent average velocity of money, current nominal Gross Domestic Product (GDP), and wanted nominal GDP. It is based on a form of the Equation of Exchange from the Quantity Theory of Money. The rule makes sense of how the Federal Reserve ought to control the supply of money to keep economic growth on a path that is sustainable over the long haul. The McCallum Rule is frequently stood out from another monetary policy rule, the Taylor Rule.

Understanding the McCallum Rule

The McCallum Rule sets a target for the monetary base in the next quarter equivalent to a linear combination of the current monetary base, the average change in the velocity of money in recent quarters, the recent growth rate of nominal GDP, and an ideal target growth rate for nominal GDP based on the long-run growth trend in real GDP and a predetermined rate of inflation accepted to be steady with supporting that long-run growth trend.

Formally the McCallum rule says:

Where:

is the natural log of the monetary base in the current quarter,

is the average change in the velocity of money over the past 16 quarters,

is the ideal rate of inflation remembered to be steady with stable long-run growth (estimated around 2% each year),

is the long-run growth rate in real GDP (estimated to be around 3% each year), and

is current growth rate in nominal GDP compared to the previous quarter.

This equation tells the Fed the amount it ought to extend or contract the monetary base, through open market operations or other policy apparatuses, with respect to the difference among genuine and wanted nominal GDP growth.

Economist Bennett T. McCallum developed the McCallum Rule in a series of papers written somewhere in the range of 1987 and 1990. Starting from the Equation of Exchange, he endeavored to capture the manner in which the monetary base of a country connects with the inflation rate and real GDP. Through these indicators, he expected to foresee what might occur in an economy under different conditions and to assign conceivable corrective measures that could be taken by the Federal Reserve Bank or other central banks.

The McCallum Rule versus the Taylor Rule

The Taylor Rule is one more economic targeting rule intended to assist central banks with controlling growth and inflation, made in 1993 by John B. Taylor, as well as Dale W. Henderson and Warwick McKibbin. It portrays an operating target for short-term interest rates in terms of the deviation of inflation and GDP growth from their ideal long-term rates.

The McCallum Rule and the Taylor Rule are many times considered rival measures to make sense of economic behavior, yet the two rules don't portray or make sense of similar relationships by any means. The Taylor Rule is essentially worried about the Federal funds rate, while the McCallum Rule portrays relationships including the monetary base.

Features

• The McCallum Rule is a monetary policy rule that involves the monetary base as an intermediate target and an ideal rate of nominal GDP growth as its ultimate goal.
• The McCallum Rule formula gives a target to the monetary base for the next quarter based on the velocity of money, current nominal GDP, and wanted nominal GDP.
• The McCallum Rule can be differentiated to the comparative Taylor Rule in monetary policy.