. 3. policy rules to inform discretionary monetary policy a third contribution of models to the monetary policy process is through simulations with alternative rules for federal reserve action. at lhm & a we designed our model to offer users four policy regimes : setting paths for the money supply, nonborrowed reserves or the federal funds rate or turning on a reaction function according to which the federal funds rate responds to developments in output, unemployment and inflation. while we increasingly used the reaction function in our analysis of alternative fiscal policies, we did not routinely take advantage of the reaction function to forecast monetary policy. another irony is that there is a much more active interest in the implications of monetary policy rules at the board, where discretionary policy is made, than in the private sector, where estimated rules might be effectively used to forecast monetary policy. the staff has examined a number of alternative rules, including those based on monetary aggregates, commodity prices, exchange rates, nominal income, and, most recently, taylor - type rules. these rules, in effect, adjust the real federal funds rate relative to some long - run equilibrium level in response to the gaps between actual and potential output and between inflation and some long - run inflation target. such a rule can be interpreted as either a descriptive or normative guide to policy. if the parameters of the policy rule are estimated over some recent sample period, the rule may describe the average response of the fomc over the period. alternatively, parameters can be derived from some optimizing framework, dependent on a specific objective function and model of the economy. stochastic simulations with such a rule can provide some confidence that following the rule will contribute to both short - run stabilization and long - term inflation goals in response to historical shocks to the economy and the rule, in turn, can provide discipline to discretionary policy by providing guidance on when and how aggressively to move interest rates in response to movements in output and inflation. the focus on rules is much more important under an interest rate operating procedure than under an operating procedure focused directly on monetary aggregate targets and is also more important under an interest rate operating procedure when the monetary aggregates, as has been the case for some time, do not bear a stable relationship to overall economic performance and therefore do not provide useful information about when and how aggressively to change interest rates. taylor - type rules, in this environment, provide a disciplined approach to varying interest rates in response to economic developments that both ensures a pro - cyclical response of interest

created by politicians out of thin air. as one of my predecessors, mr lino spiteri, wrote recently, “ they don ’ t make magic wands that work any more. ” in the real world, a key precondition for prosperity is higher productivity. it should, therefore, be our common task, but particularly that of the political class, to promote policies and practices that are conducive to a more efficient use of the nation ’ s scarce resources.