REAL INTEREST-RATES AND CENTRAL BANK OPERATING PROCEDURES

We use consumption-based CAPM models (with fixed and flexible wages) t o analyze the effect of central bank operating procedures on the ex an te real rate of return on a one-period nominal bond. We show that oper ating procedures affect both the risk-free rate and the risk premium. Nominal interest rate targeting produces the highest real interest rat es; money targeting produces the lowest rates; and nominal income targ eting comes out somewhere in between. Our simulations suggest that the central bank's choice of operating procedure may make as much as 50 o r 100 basis points difference in the real rate of interest. The role o f monetary aggregates has diminished in most central banks' operating procedures, and this provides one explanation for the common perceptio n that real interest rates may have risen. Nevertheless, our analysis also demonstrates that there is no presumption that monetary targeting dominates from a welfare point of view. (C) 1998 Elsevier Science B.V . All rights reserved.