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Parameter misspecification and robust monetary policy rules

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  • Walsh, Carl E.

Abstract

In this paper, I evaluate the performance deterioration that occurs when the central bank employs an optimal targeting rule that is based on incorrect parameter values. I focus on two parameters — the degree of inflation inertia and the degree of price stickiness. I explicitly account for the effects of the structural parameters on the objective function used to evaluate outcomes, as well as on the model’s behavioral equations. The costs of using simple rules relative to the costs of parameter misspecification are also assessed. JEL Classification: E52, E58

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0477.

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Date of creation: Apr 2005
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Handle: RePEc:ecb:ecbwps:20050477

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Keywords: Misspecification; monetary policy; Robustness;

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References

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  1. Takeshi Kimura & Takushi Kurozumi, 2003. "Optimal monetary policy in a micro-founded model with parameter uncertainty," Finance and Economics Discussion Series 2003-67, Board of Governors of the Federal Reserve System (U.S.).
  2. Alexei Onatski & Noah Williams, 2002. "Modeling model uncertainty," Discussion Papers 0203-05, Columbia University, Department of Economics.
  3. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  4. Glenn Rudebusch, 2000. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Econometric Society World Congress 2000 Contributed Papers 0065, Econometric Society.
  5. John C. Williams & Andrew T. Levin, 2003. "Robust Monetary Policy with Competing Reference Models," Computing in Economics and Finance 2003 291, Society for Computational Economics.
  6. Andrew Levin & Volker Wieland & John C. Williams, 2001. "The performance of forecast-based monetary policy rules under model uncertainty," Finance and Economics Discussion Series 2001-39, Board of Governors of the Federal Reserve System (U.S.).
  7. Onatski, Alexei & Stock, James H., 2002. "Robust Monetary Policy Under Model Uncertainty In A Small Model Of The U.S. Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 85-110, February.
  8. 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.
  9. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 581-604, April.
  10. Alexei Onatski & Noah Williams, 2004. "Empirical and policy performance of a forward-looking monetary model," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  11. Ignazio Angeloni & Gunter Coenen & Frank Smets, 2003. "Persistence, The Transmission Mechanism And Robust Monetary Policy," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 527-549, November.
  12. John C. Williams & Andrew T. Levin, 2003. "Parameter Uncertainty and the Central Bank's Objective Function," Computing in Economics and Finance 2003 215, Society for Computational Economics.
  13. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Paper Series 2003-01, Federal Reserve Bank of San Francisco.
  14. Glenn D. Rudebusch, 1999. "Is the Fed too timid? Monetary policy in an uncertain world," Working Papers in Applied Economic Theory 99-05, Federal Reserve Bank of San Francisco.
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Cited by:
  1. Robert J. Tetlow & Peter von zur Muehlen, 2005. "Robustifying learnability," Finance and Economics Discussion Series 2005-58, Board of Governors of the Federal Reserve System (U.S.).
  2. Schabert, Andreas, 2005. "Discretionary policy, multiple equilibria, and monetary instruments," Working Paper Series 0533, European Central Bank.
  3. Richard Dennis & Federico Ravenna, 2007. "Learning and optimal monetary policy," Working Paper Series 2007-19, Federal Reserve Bank of San Francisco.
  4. Amano, Robert, 2007. "Inflation persistence and monetary policy: A simple result," Economics Letters, Elsevier, vol. 94(1), pages 26-31, January.
  5. Matthias Paustian & Christian Stoltenberg, 2006. "Optimal Interest Rate Stabilization in a Basic Sticky-Price Model," SFB 649 Discussion Papers SFB649DP2006-072, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  6. Juan Paez-Farrell, 2009. "Timeless perspective vs discretionary policymaking when the degree of inflation persistence is unknown," Discussion Paper Series 2009_14, Department of Economics, Loughborough University, revised Sep 2009.
  7. Lars E.O. Svensson, 2005. "Targeting versus instrument rules for monetary policy: what is wrong with McCallum and Nelson?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 613-626.
  8. Pavasuthipaisit, Robert, 2010. "Should inflation-targeting central banks respond to exchange rate movements?," Journal of International Money and Finance, Elsevier, vol. 29(3), pages 460-485, April.
  9. Kilponen, Juha & Leitemo, Kai, 2006. "Robustness in monetary policymaking: a case for the Friedman rule," Research Discussion Papers 4/2006, Bank of Finland.
  10. Lars E.O. Svensson, 2004. "Targeting Rules vs. Instrument Rules for Monetary Policy: What is Wrong with McCallum and Nelson?," NBER Working Papers 10747, National Bureau of Economic Research, Inc.

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