Abstract: It is well recognized that monetary policy rules have an important impact on the macroeconomy. Well-gauged monetary policy can stabilize economic activities and foster growth, whereas misused policy rules can lead to severe economic fluctuations and, in extreme cases, financial crises. Therefore, it is crucial to investigate the effects of alternative policy rules on the economic environment and the desirability of different rules. Using a stylized New Keynesian dynamic stochastic general equilibrium ( DSGE) model, this paper studies the impact and desirability of three widely used monetary policy rules: the money supply rule, the Taylor rule, and the forward-looking interest rate rule.A key departure from the literature lies in our methodology. We compare the “policy space”of alternative policy rules, which enables us to get a sense of under which policy regime central banks have the most freedom to influence the policy instrument, inflation, and output. To the best of our knowledge, this issue has not been investigated. In this study, we define the policy space as the range of three parameters in policy rules: the parameters on the policy instrument, inflation, and output. Importantly, any combination in the range ( either a three-or two-dimensional space) has to have a unique equilibrium. In other words, a combination outside the range would either have no equilibrium or multiple equilibria. We argue that a good monetary policy rule should give policymakers the most degrees of freedom to influence macroeconomic targets, meaning a larger policy space.By comparing the policy space of three monetary policy rules, two results are worth highlighting. First, we find that, in general, the money supply rule is the least desirable as its policy space is the smallest, whereas the forward-looking interest rate rule is the most desirable. Second, when central banks are more concerned with controlling inflation, the Taylor rule is more desirable than the forward-looking interest rate rule, as it yields a larger range for central banks to respond to inflation.In addition, we study the welfare implications of alternative policy rules. Our welfare analysis shows that in all cases, welfare is increasing as policy rules respond to macroeconomic targets ( the policy instrument, inflation, and output) more aggressively. Furthermore, in general, when policy rules respond less aggressively to targets, the forward-looking interest rate rule yields the highest level of welfare. When monetary policy responds more aggressively to targets, the Taylor rule is the most desirable.Finally, we consider two interesting cases in which monetary policy is primarily designed for economic growth or for inflation stabilization. Our simulation results show that when monetary policy is aimed at boosting economic growth, the money supply rule is desirable. When central banks are most concerned with inflation stabilization, the Taylor rule is the most effective monetary policy rule.Our study makes a contribution to our understanding of alternative monetary policy rules and their broad impacts on the macroeconomy. We conclude that every policy rule has its pros and cons and that central banks need to exercise discretion in choosing appropriate policy rules. In terms of the policy space, the money supply rule is the least desirable. The forward-looking interest rate rule gives the most freedom to control all targets, but when policymakers are most concerned with inflation, the Taylor rule is the most desirable. In terms of welfare, the forward-looking interest rate rule yields the highest level of welfare when policy rules respond less aggressively to macroeconomic targets, and the Taylor rule is desirable when monetary policy responds more aggressively to targets. Finally, the monetary supply rule can be desirable if central banks want to boost economic growth, whereas the Taylor rule is most effective in controlling inflation.

Key Words: Monetary Policy Rules; Policy Space; Welfare Losses; Policy Targets