The Role of Central Bank Operating Procedures in an Economy with Productive Government Spending

We reexamine some of the issues related to the choice of the monetary policy instrument in a dynamic general equilibrium model exhibiting endogenous growth in which a fraction of productive government spending is financed by means of issuing currency. We evaluate the performance of four monetary instruments: monetary aggregate targeting, nominal interest rate targeting, inflation rate targeting and real interest rate targeting. We show that a switch from any other targeting procedure towards the real interest rate targeting may be welfare improving even if the real interest rate targeting is a policy that delivers the most volatile consumption in the short run. © 2010 Springer Science+Business Media, LLC.