The Tradeoff Between Improved Monetary Control and Market Interest Rate Variability in Australia

Linear quadratic optimal control techniques are applied to a simplified reduced form model of the Australian money market to examine the tradeoff between improved monetary control and interest rate variability. We focus on a series of questions. Is quarterly control of the money supply feasible in Australia? Is the tradeoff different for M1 than for M3? Does the setting of dual monetary targets worsen the tradeoff? Is the tradeoff different for open market operations than for changes in reserve requirements? Can the tradeoff be improved by the joint manipulation of reserve requirements and open market operations?