July 14, 2013
Abstract: Policy makers have a limited set of instruments with which to pursue a long list of objectives. Allocating instruments to targets involves what is called the assignment problem. The solution proposed by Jan Tinbergen and Ragnar Frisch was two-fold, namely: (i) There have to be at least as many instruments as targets; and (ii) Each instrument should be reserved for the target it is most likely to achieve. For example, in monetary policy, the instruments are money supply and the interest rate. These are most closely related to inflation and thus they should be assigned to control inflation. Deviating from the appropriate matching of instruments to targets poses risks. Thus, when the central bank of Turkey slashed its policy rate to counter currency appreciation, after a short period of success, inflationary pressures increased and the bank went back to increasing its policy rate. The broad lesson is: stay with the appropriate matching, even in situations of extreme economic stress.
Keywords: Tinbergen; Frisch; instruments; targets