For policy maker, It is usual to confront macroeconomics problems with the dilemma of choosing properly the instrument such as it match rightly a defined target(for example increase in investment or reducing inflation) . The success of stabilization macroeconomics policy depend upon the decision about the right instrument which to work with. This issue is very important in cases study related to reducing inflation programs, which has been a problem in many Latin American economies. Although empirical evidence suggest that keeping inflation under control is the job of monetary policy, some textbook experiences ,like Chilean stabilization program applied in the mid seventies and nineties, used a different approach based on exchange rate policy .The assumption was that as long as exchange rate was fixed or within certain range of value, it would allow to reduce inflationary pressures allowing authorities to get the inflation target. In both cases, the result was a failure although for different reasons. While in the seventies the assumption was that the real economy was more flexible than it really was, in the nineties the assumption was that inflation was mainly a cost push phenomena, ignoring the role of a demand pressures and how important is to keep control of them.-
Both cases are “good” examples of not following the Tinbergen rule. In the first case fixing the exchange rate meant to make monetary policy ineffective, so the task of reducing inflation was an endogenous process depending on moderate fiscal policy , but fiscal policy is better aimed for short term product goal. In the second case monetary policy capability, was artificially limited with a semi fixed exchange rate system , supposedly complemented by moderate fiscal policy. The target were confused with the instrument, fiscal policy was not moderate as expected (minimum wages law were approved, and fiscal expenditure increase over the whole period )) . The wrong belief was that inflation reduction program , did not required strong monetary policy, as the key instrument. Instead ,It was thought that exchange rate policy was better instrument for doing so, confusing cost pressures as more important than demand pressures as a cause of inflation .. Recent development in normative macroeconomics, have made quite clear that it is monetary policy the instrument to consider when it comes to get inflation under control, so much so that these days it is applied following a rule ,the well known “Taylor Rule “ which set a framework for a more effective monetary policy to get inflation target. On the other hand, the pass through coming from cost pressures is limited to ability of Central Bank to control inflationary expectations.-
The current concern about global financial market volatility, is a good opportunity to take into consideration the Tinbergen Rule. This market volatility is due not only to the subprime housing market crisis itself ,but much more so to the way authorities will react to its consequences . Both factors are complementary variables in the same equation, which means that the timing for reaction is as much important as the choosing of the proper instrument . This means that as long as this crisis is expected to roll over as a solvency crisis, the proper instrument is the discount rate .(the rate at which the Central Bank allow banks to ask for loan).The interest rate (The rate at which banks lend to each other) is the instrument for inflationary purposes, mainly to keeping demand pressures in check with potential output .