What Is the McCallum Rule?
The McCallum Rule is a monetary policy development guideline that was developed by economist Bennett T. McCallum at the end of the 20th century. The McCallum Rule uses a formula to describe the way a country's inflation and the total amount of their monetary base interact. The Rule explains how those numbers should be kept in balance.
The Rule is designed to provide policymakers with what the monetary base should be in the next quarter.
The McCallum Rule is often contrasted with another economic targeting rule, the Taylor Rule.
- The McCallum Rule is a monetary policy theory and formula describing the relationship between inflation and money supply.
- The McCallum Rule formula provides a target for the monetary base for the next quarter.
- Had the McCallum Rule been implemented prior to the 2008 financial crisis, some scholars argue it would have lessened the impact of the recession.
Understanding the McCallum Rule
The McCallum Rule is a type of nominal Gross Domestic Product (NGDP) targeting rule. A targeting rule is a formula designed to help a country's central bank know when to intervene in their money supply. A central bank may intervene by changing interest rates through the use of a variety of mechanisms to hit a specific target.
Most economic targeting rules are designed not to allow rampant inflation and a currency explosion that could destabilize the country's economy, leading to panic and recession. These rules are usually designed to achieve measured, sustainable growth. Some types of economic targeting rules rely on controlling one measure of growth or inflation. Others, such as NGDP targeting rules, look at the interaction of several areas as a way to balance them and achieve controlled growth.
Bennett T. McCallum developed the McCallum Rule in a series of papers written between 1987 and 1990. He attempted to capture the way the monetary base of a country interacts with the inflation rate. Through these indicators, he hoped to predict what would happen in an economy under various conditions and to designate possible corrective measures that could be taken by the Federal Reserve Bank or other central banks. This rule differs from many NGDP targeting rules because it places fundamental importance on the existing monetary base and what changes will occur in that base.
Essential inputs to the McCallum Rule model are the target inflation rate, monetary base, and the long-term average rate of growth in the actual gross domestic product (GDP).
Strengths and Weaknesses of the McCallum Rule
Some scholars argue that had the McCallum rule been implemented before the Great Recession of 2008, the effects of the financial crisis would have likely been less severe.
One of the downsides is that, while the rule looks at changes in several variables, it is still up to policymakers to have the information and decide what to do with it. Unlike some other rules, how to implement the rule amidst changing variables isn't always clear.
Inflation targeting may sometimes destabilize an economy, such as during a negative supply shock. Under the McCallum rule, the central bank may contract the money supply, per the McCallum rule. This may reduce inflation but wouldn't help fuel real output.
Example of How the McCallum Rule Compares to the Taylor Rule
The Taylor Rule is another economic targeting rule designed to help central banks control growth and inflation, created in 1993 by John B. Taylor, as well as Dale W. Henderson and Warwick McKibbin. It describes the effect of inflation on pricing and growth.
The McCallum Rule and the Taylor Rule are often considered rival measures to explain economic behavior, but the two rules do not describe or explain the same relationships at all. The Taylor Rule is primarily concerned with the Federal funds rate, while the McCallum Rule describes relationships involving the monetary base.