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Estimation of monetary policy preferences in a forward-looking model : a Bayesian approach

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Author Info
Pelin Ilbas () (Center for Economic Studies, Catholic University of Leuven)

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Abstract

In this paper we adopt a Bayesian approach towards the estimation of the monetary policy preference parameters in a general equilibrium framework. We start from the model presented by Smets and Wouters (2003) for the euro area where, in the original set up, monetary policy behaviour is described by an empirical Taylor rule. We abandon this way of representing monetary policy behaviour and assume, instead, that monetary policy authorities optimize an intertemporal quadratic loss function under commitment. We consider two alternative specifications for the loss function. The first specification includes inflation, output gap and difference in the interest rate as target variables. The second loss function includes an additional wage inflation target. The weights assigned to the target variables in the loss functions, i.e. the preferences of monetary policy, are estimated jointly with the structural parameters in the model. The results imply that inflation variability remains the main concern of optimal monetary policy. In addition, interest rate smoothing and the output gap appear to be, to a lesser extent, important target variables as well. Comparing the marginal likelihood of the original Smets and Wouters (2003) model to our specification with optimal monetary policy indicates that the latter performs only slightly worse. Since we are faced with the time-inconsistency problem under commitment, we initialize our estimates by considering a presample period of 40 quarters. This allows us to approach, empirically, the timeless perspective framework.

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Paper provided by National Bank of Belgium in its series Research series with number 200803-12.

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Length: 51 pages
Date of creation: Mar 2008
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Handle: RePEc:nbb:reswpp:200803-12

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Related research
Keywords: optimal monetary policy; commitment; central bank preferences; euro area monetary policy;

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Find related papers by JEL classification:
E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
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
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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Cited by:
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  1. Gregory Erin Givens, 2009. "Estimating Central Bank Preferences under Commitment and Discretion," Working Papers 200905, Middle Tennessee State University, Department of Economics and Finance. [Downloadable!]
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