A monetary policy rule based on fuzzy control in an inflation targeting framework

Abstract

Today inflation targeting regime is often used to conduct monetary policy in most developed economies. In this regime, a central bank manipulates its key interest rate to steer an economy to the objectives it wants to achieve. To implement its monetary policy, Taylor rule is claimed to be a quantitative tool used as a guide for setting interest rate in response to the state of the economy. Despite its widespread popularity, the Taylor rule is just an orientational guidance at best and cannot be followed strictly since it would be against the common practice of conducting monetary policy of most central banks. Therefore, we propose a new rule for inflation targeting monetary policy based on fuzzy control technique. This rule seems to be able to quantify those widely accepted qualitative knowledge on monetary policy. Further, the policy derived by this rule also better captures the common behaviour of central banks. We verify this rule on the monetary policy conducted by the Czech National Bank in the period from 2000 to 2011. We also compare the result of this rule with the results obtained by implementing monetary policy by some other alternative rules.