A Model for Monetary Policy Analysis in Uruguay

Uruguay has recently reverted to a money targeting (MT) framework in the context of adisinflation strategy. We develop a quantitative model for monetary policy analysisincorporating money targets in the policy framework while also retaining a central role forinterest rates in the transmission of policy. We use the model to show that tight financialconditions for a period may be necessary for inflation to converge to the middle of the targetband. We also discuss various aspects of the MT framework. Two issues stand out. Excessivefocus on hitting money targets can result in undesirable changes in the policy stance; whiletargets that incorporate elements of money demand forecasting are superior to targets that areexcessively smooth or do not adjust for base effects.