Advanced Search
MyIDEAS: Login to save this book chapter or follow this series

Robustness of Simple Monetary Policy Rules under Model Uncertainty

In: Monetary Policy Rules

Contents:

Author Info

  • Andrew T.. Levin
  • Volker Wieland
  • John Williams

Abstract

In this paper, we investigate the properties of alternative monetary policy rules using four structural macroeconometric models: the Fuhrer-Moore model, Taylor's Multi-Country Model, the MSR model of Orphanides and Wieland, and the FRB staff model. All four models incorporate the assumptions of rational expectations, short-run nominal inertia, and long-run monetary neutrality, but differ in many other respects (e.g., the dynamics of prices and real expenditures). We compute the output-inflation volatility frontier of each model for alternative specifications of the interest rate rule, subject to an upper bound on nominal interest rate volatility. Our analysis provides strong support for rules in which the first-difference of the federal funds rate responds to the current output gap and the deviaition of the 1-year average inflation rate from a specified target. In all 4 models, first-difference rules perform much better than rules of the type proposed by Taylor (1993) and Henderson and McKibbin (1993), in which the level of the federal funds rate responds to the output gap and inflation deviation fromt target. Furthermore, first-difference rules generate essentially the same policy frontier as more complicated rules (i.e. rules that respond to a larger number of variables and/or additional lags of output and inflation). Finally, this class of rules is robust to model uncertainty, in the sense that a first-difference rule taken from the policy frontier of one model is very close to the policy frontier of each of the other three models. In contrast, more complicated rules are less robust to model uncertainty: rules with additional parameters can be fine-tuned to the dynamics of a specified model, but typically perform poorly in the other models.

(This abstract was borrowed from another version of this item.)

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/chapters/c7418.pdf
Download Restriction: no

Bibliographic Info

as in new window

This chapter was published in:

  • John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 7418.

    Handle: RePEc:nbr:nberch:7418

    Contact details of provider:
    Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Email:
    Web page: http://www.nber.org
    More information through EDIRC

    Related research

    Keywords:

    Other versions of this item:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. John B. Taylor, 1995. "Monetary policy implications of greater fiscal discipline," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 151-170.
    2. Fair, Ray C. & Howrey, E. Philip, 1996. "Evaluating alternative monetary policy rules," Journal of Monetary Economics, Elsevier, Elsevier, vol. 38(2), pages 173-193, October.
    3. Volker Wieland, 1998. "Monetary policy and uncertainty about the natural unemployment rate," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1998-22, Board of Governors of the Federal Reserve System (U.S.).
    4. Kendrick, David, 1982. "Caution and probing in a macroeconomic model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 4(1), pages 149-170, November.
    5. Caplin, Andrew & Leahy, John, 1996. "Monetary Policy as a Process of Search," American Economic Review, American Economic Association, American Economic Association, vol. 86(4), pages 689-702, September.
    6. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, Reserve Bank of Australia, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
    7. John C. Williams, 1999. "Simple rules for monetary policy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1999-12, Board of Governors of the Federal Reserve System (U.S.).
    8. Anderson, Gary S., 2010. "A reliable and computationally efficient algorithm for imposing the saddle point property in dynamic models," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(3), pages 472-489, March.
    9. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper, Federal Reserve Bank of Richmond 90-06, Federal Reserve Bank of Richmond.
    10. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
    11. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
    12. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
    13. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3892, C.E.P.R. Discussion Papers.
    14. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
    15. Lars Peter Hansen & Thomas J. Sargent, 1990. "Recursive Linear Models of Dynamic Economies," NBER Working Papers 3479, National Bureau of Economic Research, Inc.
    16. Becker, Robin G, et al, 1986. "The Simultaneous Use of Rival Models in Public Optimisation," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 96(382), pages 425-48, June.
    17. Mankiw, N. Gregory (ed.), 1997. "Monetary Policy," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226503097.
    18. Bennett T. McCallum & Edward Nelson, 1997. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc.
    19. Christodoulakis, Nicos & Kemball-Cook, David & Levine, Paul, 1993. "The Design of Economic Policy under Model Uncertainty," Computational Economics, Society for Computational Economics, Society for Computational Economics, vol. 6(3-4), pages 219-40, November.
    20. Henderson, Dale W. & McKibbin, Warwick J., 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 221-317, December.
    21. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers, Board of Governors of the Federal Reserve System (U.S.) 2, Board of Governors of the Federal Reserve System (U.S.).
    22. David Reifschneider & John C. Williams, 1999. "Three lessons for monetary policy in a low inflation era," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1999-44, Board of Governors of the Federal Reserve System (U.S.).
    23. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
    24. Frankel, Jeffrey A & Rockett, Katharine E, 1988. "International Macroeconomic Policy Coordination When Policymakers Do Not Agree on the True Model," American Economic Review, American Economic Association, American Economic Association, vol. 78(3), pages 318-40, June.
    25. Karakitsos, E. & Rustem, B., 1984. "Optimally derived fixed rules and indicators," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 8(1), pages 33-64, October.
    26. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1989, C.E.P.R. Discussion Papers.
    27. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, Econometric Society, vol. 47(5), pages 1267-86, September.
    28. Rebelo, S. & Xie, D., 1996. "On the Optimality of Interest Rate Smoothing," RCER Working Papers 427, University of Rochester - Center for Economic Research (RCER).
    29. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(1), pages 163-90, February.
    30. P.A. Tinsley, 1993. "Fitting both data and theories: polynomial adjustment costs and error- correction decision rules," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 93-21, Board of Governors of the Federal Reserve System (U.S.).
    31. Andrew Levin & John Rogers & Ralph Tryon, 1997. "Evaluating international economic policy with the Federal Reserve's global model," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), Board of Governors of the Federal Reserve System (U.S.), issue Oct, pages 797-817.
    32. Balvers, Ronald J & Cosimano, Thomas F, 1994. "Inflation Variability and Gradualist Monetary Policy," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 61(4), pages 721-38, October.
    33. Holtham, Gerald & Hughes Hallett, Andrew, 1992. "International Macroeconomic Policy Coordination When Policymakers Do Not Agree on the True Model: Comment," American Economic Review, American Economic Association, American Economic Association, vol. 82(4), pages 1043-51, September.
    34. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1998-03, Board of Governors of the Federal Reserve System (U.S.).
    35. Lawrence J. Christiano & Martin Eichenbaum, 1993. "Interest rate smoothing in an equilibrium business cycle model," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
    36. Wieland, Volker, 1996. "Monetary policy targets and the stabilization objective: a source of tension in the EMS," Journal of International Money and Finance, Elsevier, Elsevier, vol. 15(1), pages 95-116, February.
    37. Buiter, Willem H & Jewitt, Ian, 1981. "Staggered Wage Setting with Real Wage Relativities: Variations on a Theme of Taylor," The Manchester School of Economic & Social Studies, University of Manchester, University of Manchester, vol. 49(3), pages 211-28, September.
    38. Brayton, Flint & Levin, Andrew & Lyon, Ralph & Williams, John C., 1997. "The evolution of macro models at the Federal Reserve Board," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 47(1), pages 43-81, December.
    39. Fuhrer, Jeffrey C, 1997. "Inflation/Output Variance Trade-Offs and Optimal Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 29(2), pages 214-34, May.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:nbr:nberch:7418. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.