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The Performance and Robustness of Simple Monetary Policy Rules in Models of the Canadian Economy

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  • Denise Côté
  • John Kuszczak
  • Jean-Paul Lam
  • Ying Liu
  • Pierre St-Amant

Abstract

In this report, we evaluate several simple monetary policy rules in twelve private and public sector models of the Canadian economy. Our results indicate that none of the simple policy rules we examined is robust to model uncertainty, in that no single rule performs well in all models. In fact, our results show that the performance of some of the simple rules, particularly interest-rate-smoothing rules and rules that have a high coefficient on the inflation gap, can substantially deviate from the optimal rule and can even be unstable in some models. Our results are thus very different from those of Levin, Wieland, and Williams (1999), who argue that simple policy rules are not only robust but also generate essentially the same policy frontier as more complicated rules or rules that respond to a large number of variables. Furthermore, we find that open-economy rules do not perform well in many models. In fact, we find that adding an exchange rate term to a simple policy rule often increases the loss-function value. This result is thus very different from that of Ball (1999), who argues in favour of a rule that includes the exchange rate. Although it is not robust, we find that a simple nominal Taylor-type rule that has a coefficient of 2 on the inflation gap and 0.5 on the output gap outperforms the other simple rules in a certain class of models. But even in those models the loss-function value of this simple rule can substantially deviate from the optimal or base-case rule.

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File URL: http://www.bankofcanada.ca/en/res/tr/2002/tr92.pdf
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Bibliographic Info

Paper provided by Bank of Canada in its series Technical Reports with number 92.

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Length: 36 pages
Date of creation: 2002
Date of revision:
Handle: RePEc:bca:bocatr:92

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Keywords: Uncertainty and monetary policy;

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References

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  1. Lawrence J. Christiano & Christopher J. Gust, 1999. "Taylor Rules in a Limited Participation Model," NBER Working Papers 7017, National Bureau of Economic Research, Inc.
  2. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," International Tax and Public Finance, Springer, vol. 6(4), pages 537-577, November.
  3. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  4. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  5. Christopher A. Sims, 2001. "A Review of Monetary Policy Rules," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 562-566, June.
  6. Leitemo, Kai & Soderstrom, Ulf, 2005. "Simple monetary policy rules and exchange rate uncertainty," Journal of International Money and Finance, Elsevier, vol. 24(3), pages 481-507, April.
  7. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  8. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  9. Hamid Faruqee & Douglas Laxton & Bart Turtelboom & Peter Isard & Eswar Prasad, 1998. "Multimod Mark III," IMF Occasional Papers 164, International Monetary Fund.
  10. Stephen Murchison, . "NAOMI A New Quarterly Forecasting Model Part II: A Guide to Canadian NAOMI," Working Papers-Department of Finance Canada 2001-25, Department of Finance Canada.
  11. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
  12. Jamie Armour & Ben Fung & Dinah Maclean, 2002. "Taylor Rules in the Quarterly Projection Model," Working Papers 02-1, Bank of Canada.
  13. 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.
  14. Robert L. Hetzel, 2000. "The Taylor rule : is it a useful guide to understanding monetary policy?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 1-33.
  15. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
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