Risk Management in Action. Robust monetary policy rules under structured uncertainty
Abstract
Recent interest in ‘Risk Management’ has highlighted the relevance of Bayesian analysis for robust monetary-policy making. This paper sets out a comprehensive methodology for designing policy rules inspired by such considerations. We design rules that are robust with respect to model uncertainty facing both the policymaker and private sector. We apply our methodology to three simple interest-rate rules: inflation-forecast-based (IFB) rules with a discrete forward horizon, one targeting a discounted sum of forward inflation, and a current wage inflation rule. We use an estimated DSGE model of the euro area and estimated measures of structured exogenous and parameter uncertainty for the exercise. We find that IFB rules with a long horizon perform poorly with or without robust design. Our discounted future targeting rule performs much better, indicating that policy can be highly forward-looking without compromising stabilization. The wage inflation rule dominates whether it is designed to have good robust properties or not. JEL Classification: E52, E37, E58.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.Bibliographic Info
Paper provided by European Central Bank in its series Working Paper Series with number 870.Length: 62 pages
Date of creation: Feb 2008
Date of revision:
Handle: RePEc:ecb:ecbwps:20080870
Contact details of provider:
Postal: Postfach 16 03 19, Frankfurt am Main, Germany
Phone: +49 69 1344 0
Fax: +49 69 1344 6000
Web page: http://www.ecb.europa.eu/home/html/index.en.html
More information through EDIRC
Order Information:
Postal: Press and Information Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany
Email:
Related research
Keywords: Interest-rate rules; robustness; structured uncertainty.;Find related papers by JEL classification:
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-03-15 (All new papers)
- NEP-CBA-2008-03-15 (Central Banking)
- NEP-MAC-2008-03-15 (Macroeconomics)
- NEP-MON-2008-03-15 (Monetary Economics)
References
References listed on IDEASPlease 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.:
- Adalid, Ramon & Coenen, Gunter & McAdam, Peter & Siviero, Stefano, 2005.
"The Performance and Robustness of Interest-Rate Rules in Models of the Euro Area,"
MPRA Paper
821, University Library of Munich, Germany.
- Ramón Adalid & Günter Coenen & Peter McAdam & Stefano Siviero, 2005. "The Performance and Robustness of Interest-Rate Rules in Models of the Euro Area," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May.
- Ramón Adalid & Günter Coenen & Peter McAdam & Stefano Siviero, 2005. "The performance and robustness of interest-rate rules in models of the euro area," Working Paper Series 479, European Central Bank.
- Malcolm D. Knight & Chair, 2003. "Implications of a changing economic structure for the strategy of monetary policy," Proceedings, Federal Reserve Bank of Kansas City, pages 361-371.
- Giovanni Lombardo & David Vestin, 2007.
"Welfare implications of Calvo vs. Rotemberg pricing assumptions,"
Working Paper Series
770, European Central Bank.
- Lombardo, Giovanni & Vestin, David, 2008. "Welfare implications of Calvo vs. Rotemberg-pricing assumptions," Economics Letters, Elsevier, vol. 100(2), pages 275-279, August.
- 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, vol. 78(3), pages 318-40, June.
- Frank Smets & Ignazio Angeloni & Gunter Coenen, 2003.
"Persistence, the Transmission Mechanism and Robust Monetary Policy,"
Computing in Economics and Finance 2003
137, Society for Computational Economics.
- 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.
- Ignazio Angeloni & Günter Coenen & Frank Smets, 2003. "Persistence, the transmission mechanism and robust monetary policy," Working Paper Series 250, European Central Bank.
- Günter Coenen & Peter McAdam & Roland Straub, 2007.
"Tax reform and labour-market performance in the euro area - a simulation-based analysis using the New Area-Wide Model,"
Working Paper Series
747, European Central Bank.
- Coenen, Günter & McAdam, Peter & Straub, Roland, 2008. "Tax reform and labour-market performance in the euro area: A simulation-based analysis using the New Area-Wide Model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2543-2583, August.
- Günter Coenen & Volker Wieland, 2003.
"The Zero-interest-rate bound and the role of the exchange rate for monetary policy in Japan,"
Working Paper Series
218, European Central Bank.
- Coenen, Gunter & Wieland, Volker, 2003. "The zero-interest-rate bound and the role of the exchange rate for monetary policy in Japan," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1071-1101, July.
- Volker Wieland & Gunter Coenen, 2003. "The Zero-Interest-Rate Bound and the Role of the Exchange Rate for Monetary Policy in Japan," Computing in Economics and Finance 2003 138, Society for Computational Economics.
- Coenen, Günter & Wieland, Volker, 2003. "The Zero-Interest Rate Bound and the Role of the Exchange Rate for Monetary Policy in Japan," CEPR Discussion Papers 3895, C.E.P.R. Discussion Papers.
- Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
- Eggertsson, Gauti B., 2006. "The Deflation Bias and Committing to Being Irresponsible," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 283-321, March.
- David G. Blanchflower & Chris Shadforth, 2007.
"Fear, Unemployment and Migration,"
NBER Working Papers
13506, National Bureau of Economic Research, Inc.
- DavidG. Blanchflower & Chris Shadforth, 2009. "Fear, Unemployment and Migration," Economic Journal, Royal Economic Society, vol. 119(535), pages F136-F182, 02.
- 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.
- Timothy Cogley & Thomas J. Sargent, 2005. "The conquest of U.S. inflation: learning and robustness to model uncertainty," Working Paper Series 478, European Central Bank.
- Nicoletta Batini & Joe Pearlman, 2002.
"Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules,"
Computing in Economics and Finance 2002
182, Society for Computational Economics.
- Nicoletta Batini & Joseph Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Discussion Papers 08, Monetary Policy Committee Unit, Bank of England.
- Paul Levine & Joseph Pearlman, 2007.
"Robust Monetary Rules under Unstructured and Structured Model Uncertainty,"
School of Economics Discussion Papers
0707, School of Economics, University of Surrey.
- Paul Levine & Joseph Pearlman, 2008. "Robust monetary rules under unstructured and structured model uncertainty," Working Paper Series 899, European Central Bank.
- Adam, Klaus & Billi, Roberto M., 2007.
"Discretionary monetary policy and the zero lower bound on nominal interest rates,"
Journal of Monetary Economics,
Elsevier, vol. 54(3), pages 728-752, April.
- Klaus Adam & Roberto Billi, 2005. "Discretionary Monetary Policy and the Zero Lower Bound on Nominal Interest Rates," CFS Working Paper Series 2005/16, Center for Financial Studies.
- Klaus Adam & Roberto M. Billi, 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Research Working Paper RWP 05-08, Federal Reserve Bank of Kansas City.
- Otrok, Christopher, 2001.
"On measuring the welfare cost of business cycles,"
Journal of Monetary Economics,
Elsevier, vol. 47(1), pages 61-92, February.
- Chris Otrok, 1999. "On Measuring the Welfare Cost of Business Cycles," Virginia Economics Online Papers 318, University of Virginia, Department of Economics.
- Christopher Otrok, 2000. "On Measuring the Welfare Cost of Business Cycles," Econometric Society World Congress 2000 Contributed Papers 1094, Econometric Society.
- Currie,David & Levine,Paul, 2009.
"Rules, Reputation and Macroeconomic Policy Coordination,"
Cambridge Books,
Cambridge University Press, number 9780521104609.
- Currie,David & Levine,Paul, 1993. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521441964.
- J. Tetlow, Robert & von zur Muehlen, Peter, 2001.
"Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 25(6-7), pages 911-949, June.
- Robert J. Tetlow & Peter von zur Muehlen, 2000. "Robust monetary policy with misspecified models: does model uncertainty always call for attenuated policy?," Finance and Economics Discussion Series 2000-28, Board of Governors of the Federal Reserve System (U.S.).
- Walsh, Carl E., 2004.
"Implications of a Changing Economic Structure for the Strategy of Monetary Policy,"
Santa Cruz Center for International Economics, Working Paper Series
qt84g1q1g6, Center for International Economics, UC Santa Cruz.
- Carl E. Walsh, 2003. "Implications of a changing economic structure for the strategy of monetary policy," Proceedings, Federal Reserve Bank of Kansas City, pages 297-348.
- Walsh, Carl E., 2004. "Implications of a Changing Economic Structure for the Strategy of Monetary Policy," Santa Cruz Department of Economics, Working Paper Series qt84g1q1g6, Department of Economics, UC Santa Cruz.
- William Brock & Steven Durlauf & Kenneth West, 2005.
"Model uncertainty and policy evaluation: some theory and empirics,"
Proceedings,
Federal Reserve Bank of San Francisco.
- Brock, William A. & Durlauf, Steven N. & West, Kenneth D., 2007. "Model uncertainty and policy evaluation: Some theory and empirics," Journal of Econometrics, Elsevier, vol. 136(2), pages 629-664, February.
- William A. Brock & Steven N. Durlauf & Kenneth D. West, 2004. "Model Uncertainty and Policy Evaluation: Some Theory and Empirics," NBER Working Papers 10916, National Bureau of Economic Research, Inc.
- Brock,W.A. & Durlauf,S.N. & West,K.D., 2004. "Model uncertainty and policy evaluation : some theory and empirics," Working papers 19, Wisconsin Madison - Social Systems.
- DeJong, David N. & Ingram, Beth F. & Whiteman, Charles H., 2000. "A Bayesian approach to dynamic macroeconomics," Journal of Econometrics, Elsevier, vol. 98(2), pages 203-223, October.
- Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Simple and Implementable Monetary and Fiscal Rules: Expanded Version," NBER Working Papers 12402, National Bureau of Economic Research, Inc.
- Paul Levine & Joseph Pearlman & Richard Pierse, 2007.
"Linear-quadratic approximation, external habit and targeting rules,"
Working Paper Series
759, European Central Bank.
- Levine, Paul & Pearlman, Joseph & Pierse, Richard, 2008. "Linear-quadratic approximation, external habit and targeting rules," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3315-3349, October.
- Coenen, Gunter, 2007.
"Inflation persistence and robust monetary policy design,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 31(1), pages 111-140, January.
- Günter Coenen, 2003. "Inflation persistence and robust monetary policy design," Working Paper Series 290, European Central Bank.
- 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.
- Paul Levine & Peter McAdam & Joseph Pearlman, 2007.
"Inflation-Forecast-Based Rules and Indeterminacy: A Puzzle and a Resolution,"
International Journal of Central Banking,
International Journal of Central Banking, vol. 3(4), pages 77-110, December.
- Paul Levine & Peter McAdam & Joseph Pearlman, 2006. "Inflation forecast-based-rules and indeterminacy: a puzzle and a resolution," Working Paper Series 643, European Central Bank.
- Richard Layard, 2006. "Happiness and Public Policy: a Challenge to the Profession," Economic Journal, Royal Economic Society, vol. 116(510), pages C24-C33, 03.
- Layard, Richard, 2006. "Happiness and public policy: a challenge to the profession," Open Access publications from London School of Economics and Political Science http://eprints.lse.ac.uk/, London School of Economics and Political Science.
- Levine, Paul, 1986. "The formulation of robust policies for rival rational expectations models of the economy," Journal of Economic Dynamics and Control, Elsevier, vol. 10(1-2), pages 93-97, June.
- David N. DeJong & Beth F. Ingram & Charles H. Whiteman, 2000. "Keynesian impulses versus Solow residuals: identifying sources of business cycle fluctuations," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(3), pages 311-329.
- 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, vol. 82(4), pages 1043-51, September.
- Choudhary, M. Ali & Levine, Paul, 2006. "Idle worship," Economics Letters, Elsevier, vol. 90(1), pages 77-83, January.
Citations
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.Cited by:
- Paul Levine & Joseph Pearlman & Peter Welz, 2008. "Robust Inflation-Targeting Rules and the Gains from International Policy Coordination," School of Economics Discussion Papers 0208, School of Economics, University of Surrey.
- Levine, Paul, 2010.
"Monetary policy in an uncertain world: Probability models and the design of robust monetary rules,"
Working Papers
10/72, National Institute of Public Finance and Policy.
- Paul Levine, 2010. "Monetary Policy in an Uncertain World: Probability Models and the Design of Robust Monetary Rules," Working Papers id:2761, eSocialSciences.
- Paul Levine, 2010. "Monetary Policy in an Uncertain World: Probability Models and the Design of Robust Monetary Rules," School of Economics Discussion Papers 0210, School of Economics, University of Surrey.
- Paul Levine, 2010. "Monetary Policy in an Uncertain World : Probability Models and the Design of Robust Monetary Rules," Macroeconomics Working Papers 21853, East Asian Bureau of Economic Research.
- Paul Levine & Joseph Pearlman, 2007.
"Robust Monetary Rules under Unstructured and Structured Model Uncertainty,"
School of Economics Discussion Papers
0707, School of Economics, University of Surrey.
- Paul Levine & Joseph Pearlman, 2008. "Robust monetary rules under unstructured and structured model uncertainty," Working Paper Series 899, European Central Bank.
- Cogley, Timothy & de Paoli, Bianca & Matthes, Christian & Nikolov, Kalin & Yates, Tony, 2011.
"A Bayesian approach to optimal monetary policy with parameter and model uncertainty,"
Bank of England working papers
414, Bank of England.
- Cogley, Timothy & De Paoli, Bianca & Matthes, Christian & Nikolov, Kalin & Yates, Tony, 2011. "A Bayesian approach to optimal monetary policy with parameter and model uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 2186-2212.
- Levine, Paul & Pearlman, Joseph, 2010. "Robust monetary rules under unstructured model uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 456-471, March.
- Paul Levine, 2012. "Policy focus: Monetary policy in an uncertain world: probability models and the design of robust monetary rules," Indian Growth and Development Review, Emerald Group Publishing, vol. 5(1), pages 70-88, April.
Lists
This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.Statistics
Access and download statisticsCorrections
When requesting a correction, please mention this item's handle: RePEc:ecb:ecbwps:20080870For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Official Publications).
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.

