Tinbergen Rule and Trying To Do Too Much

 

The Tinbergen Rule, named after one of the first winners of the Nobel Prize in economics, states that "n" independent policy targets need "n" policy instruments. There are actually 3 main variables in the Tinbergen set-up, data which is independent, the target variable which could be inflation, GDP, unemployment, and/or financial stability, and the policy instrument which is in a broad sense monetary and fiscal policy. More specifically, the monetary policy instrument could be the short rate controlled by the Fed. Fiscal policy may be tax and spending policies. Governments can also use regulation to reach their targets. In this case, regulation can enhance financial stability.

Think about the Tinbergen Rule in the context of the current market environment.  A monetary policy target is 2% inflation, but if you use monetary policy to raise rates, you will have a problem with growth or financial stability.  You can have a policy instrument that may be at odds with a given target. Raising rates may increase the likelihood of a recession or increase financial instability. 

A quick review of the Tinbergen Rule suggests that a given policy mix can be ineffective at reaching specific targets.  This is old school thinking, but it shines a strong light in the limitations of monetary and fiscal policy.