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Optimal Forward-Looking Policy Rules in the Quarterly Projection Model of the Czech National Bank

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Author Info
Jan Strasky
Abstract

This paper analyses the performance of the inflation forecast-based (IFB) monetary policy rules in the quarterly projection model of the Czech National Bank. The paper begins by reviewing the model and its parametrization, including the variance-covariance matrix of disturbances employed in simulations. The main part of the paper presents the results of an extensive grid search over various targeting horizons and coefficient values for a simple IFB rule with optimized coefficients, and suggests three possibilities for improvement: a shorter targeting horizon, a higher relative weight placed on inflation gap stabilization, and a lower coefficient on partial interest rate adjustment. These results are supported by an analysis of the impact of individual shocks on the optimal coefficients of the IFB rule. The last section of the paper argues for inclusion of the real exchange rate stabilization objective in the policy maker’s loss function and repeats the grid search for an optimal rule allowing for the real exchange rate feedback term. The previous results are not dramatically altered and we conclude that the stabilization properties of the extended rules are comparable with the those of the original optimized IFB rules.

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Paper provided by Czech National Bank, Research Department in its series Research and Policy Notes with number 2005/05.

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Date of creation: Dec 2005
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Handle: RePEc:cnb:rpnrpn:2005/05

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Related research
Keywords: Exchange rates; inflation targeting; monetary policy rules; open economy.;

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  2. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April. [Downloadable!] (restricted)
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  3. Katerina Smidkova & Ray Barrell & Dawn Holland, 2002. "Estimates of Fundamental Real Exchange Rates for the Five EU Pre-Accession Countries," Working Papers 2002/03, Czech National Bank, Research Department. [Downloadable!]
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  4. Dennis, Richard, 2004. "Solving for optimal simple rules in rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(8), pages 1635-1660, June. [Downloadable!] (restricted)
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  5. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  6. Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies. [Downloadable!]
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  7. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
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  8. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
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  10. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June. [Downloadable!] (restricted)
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  11. Fabio Ghironi & Alessandro Rebucci, 2002. "Monetary Rules for Emerging Market Economies," IMF Working Papers 02/34, International Monetary Fund. [Downloadable!]
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  12. Goldstein, Morris & Khan, Mohsin S., 1985. "Income and price effects in foreign trade," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 20, pages 1041-1105 Elsevier. [Downloadable!] (restricted)
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  15. Juan Pablo Medina & Rodrigo Valdés, 2000. "Optimal Monetary Policy Rules when the Current Account Matters," Working Papers Central Bank of Chile 77, Central Bank of Chile. [Downloadable!]
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