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Monetary Policy With A Wider Information Set: A Bayesian Model Averaging Approach

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  • Fabio Milani

Abstract

Monetary policy has been usually analyzed in the context of small macroeconomic models where central banks are allowed to exploit a limited amount of information. Under these frameworks, researchers typically derive the optimality of aggressive monetary rules, contrasting with the observed policy conservatism and interest rate smoothing. This paper allows the central bank to exploit a wider information set, while taking into account the associated model uncertainty, by employing Bayesian Model Averaging with Markov Chain Model Composition (MC³). In this enriched environment, we derive the optimality of smoother and more cautious policy rates, together with clear gains in macroeconomic efficiency.

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Bibliographic Info

Article provided by Scottish Economic Society in its journal Scottish Journal of Political Economy.

Volume (Year): 55 (2008)
Issue (Month): 1 (02)
Pages: 1-30

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Handle: RePEc:bla:scotjp:v:55:y:2008:i:1:p:1-30

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  1. Rudebusch, Glenn D. & Svensson, Lars E. O., 2002. "Eurosystem monetary targeting: Lessons from U.S. data," European Economic Review, Elsevier, Elsevier, vol. 46(3), pages 417-442, March.
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  3. Carmen Fernandez & Eduardo Ley & Mark Steel, 1999. "Model uncertainty in cross-country growth regressions," Econometrics, EconWPA 9903003, EconWPA, revised 06 Oct 2001.
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  5. Timothy Cogley & Thomas J. Sargent, 2005. "The conquest of US inflation: Learning and robustness to model uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 528-563, April.
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  7. Favero, Carlo A & Milani, Fabio, 2005. "Parameter Instability, Model Uncertainty and the Choice of Monetary Policy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4909, C.E.P.R. Discussion Papers.
  8. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, Elsevier, vol. 47(5), pages 791-831, October.
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  12. Brock,W.A. & Durlauf,S.N. & West,K.D., 2003. "Policy evaluation in uncertain economic environments," Working papers, Wisconsin Madison - Social Systems 15, Wisconsin Madison - Social Systems.
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  14. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, American Economic Association, vol. 91(4), pages 964-985, September.
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  17. Robert Tetlow, 2000. "The Fed Is Not As Ignorant As You Think," Computing in Economics and Finance 2000, Society for Computational Economics 202, Society for Computational Economics.
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  19. Christopher A. Sims, 2002. "The Role of Models and Probabilities in the Monetary Policy Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 1-62.
  20. Fabio Milani, 2003. "Adaptive Learning, Model Uncertainty and Monetary Policy Inertia in a Large Information Environment," Computing in Economics and Finance 2003, Society for Computational Economics 280, Society for Computational Economics.
  21. Christopher A. Sims, 2001. "Pitfalls of a Minimax Approach to Model Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 51-54, May.
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Citations

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Cited by:
  1. Gonzalez F. & Rodriguez A. & Gonzalez-Garcia J.R., 2005. "Uncertainty about the Persistence of Periods with Large Price Shocks and the Optimal Reaction of the Monetary Authority," Computing in Economics and Finance 2005, Society for Computational Economics 402, Society for Computational Economics.
  2. Fabrizio Zampolli, 2004. "Optimal monetary policy in a regime-switching economy," Computing in Economics and Finance 2004, Society for Computational Economics 166, Society for Computational Economics.
  3. Garett Jones & W. Schneider, 2006. "Intelligence, Human Capital, and Economic Growth: A Bayesian Averaging of Classical Estimates (BACE) Approach," Journal of Economic Growth, Springer, Springer, vol. 11(1), pages 71-93, 03.
  4. Zampolli, Fabrizio, 2006. "Optimal monetary policy in a regime-switching economy: The response to abrupt shifts in exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 30(9-10), pages 1527-1567.
  5. Arnulfo Rodríguez & Fidel González & Jesús R. González García, 2007. "Uncertainty about the Persistence of Cost-Push Shocks and the Optimal Reaction of the Monetary Authority," Working Papers, Banco de México 2007-05, Banco de México.
  6. Arnulfo Rodríguez & Pedro N. Rodríguez, 2007. "Recursive Thick Modeling and the Choice of Monetary Policy in Mexico," Working Papers, Banco de México 2007-04, Banco de México.
  7. Maltritz, Dominik & Molchanov, Alexander, 2013. "Analyzing determinants of bond yield spreads with Bayesian Model Averaging," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(12), pages 5275-5284.
  8. Maltritz, Dominik, 2012. "Determinants of sovereign yield spreads in the Eurozone: A Bayesian approach," Journal of International Money and Finance, Elsevier, Elsevier, vol. 31(3), pages 657-672.
  9. Arnulfo Rodriguez & Pedro N. Rodriguez, 2006. "Recursive Thick Modeling and the Choice of Monetary Policy in Mexico," Computing in Economics and Finance 2006, Society for Computational Economics 30, Society for Computational Economics.

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