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Optimal Monetary Policy rules for the Euro area in a DSGE framework

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  • Pelin Ilbas

Abstract

This paper evaluates optimal monetary policy rules within the context of a dynamic stochastic general equilibrium model estimated for the Euro Area. Under assumption of an ad hoc loss function for the central bank, we compute the unconditional losses both under discretion and commitment. We compare the performance of unrestricted optimal rules to the performance of optimal simple rules. The results indicate that there are considerable gains from commitment over discretion, probably due to the stabilization bias present under discretion. The lagged variant of the Taylor type of rule that allows for interest rate inertia does relatively well in approaching the performance of the unrestricted optimal rule derived under commitment. On the other hand, simple rules expressed in terms of forecasts to next period’s inflation rate seem to perform relatively worse.

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Paper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiën in its series Center for Economic Studies - Discussion papers with number ces0613.

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Date of creation: Mar 2006
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Handle: RePEc:ete:ceswps:ces0613

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Keywords: optimal rules; commitment; discretion; stabilization bias;

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Cited by:
  1. Deren Unalmis & Ibrahim Unalmis & Derya Filiz Unsal, 2008. "Oil Price Shocks, Macroeconomics Stability and Welfare in a Small Open Economy," Discussion Papers 08/13, Department of Economics, University of York.

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