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

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  • Pelin Ilbas

    () (Center for Economic Studies, Catholic University of Leuven)

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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Bibliographic Info

Paper provided by National Bank of Belgium in its series Working Paper Research with number 129.

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

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

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Cited by:
  1. Gregory Erin Givens & Michael K. Salemi, 2006. "Generalized Method of Moments and Inverse Control," Working Papers 200603, Middle Tennessee State University, Department of Economics and Finance.
  2. Van Beveren, Ilke & Bernard, Andrew B & Blanchard, Emily J & Vandenbussche, Hylke, 2011. "Carry-along trade," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/387875, Katholieke Universiteit Leuven.
  3. Fiodendji, Komlan, 2011. "Should Canadian Monetary Policy Respond to Asset Prices? Evidence from a Structural Model," MPRA Paper 27942, University Library of Munich, Germany.
  4. FIodendji, Komlan, 2011. "Should Canadian monetary policy respond to asset prices? Evidence from a structural model," MPRA Paper 28039, University Library of Munich, Germany, revised 10 Jan 2011.
  5. Joachim Keller, 2008. "Agency problems in structured finance – a case study of European CLOs," Working Paper Document 137, National Bank of Belgium.
  6. Daniel Komlan Fiodendji, 2012. "Should Canadian Monetary Policy Respond to Asset Prices? Evidence from a Structural Model," Working Papers 1209E, University of Ottawa, Department of Economics.
  7. Gregory E. Givens, 2012. "Estimating Central Bank Preferences under Commitment and Discretion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(6), pages 1033-1061, 09.
  8. Abraham, Filip & Van Hove, Jan, 2010. "Can Belgian firms cope with the Chinese dragon and Asian tigers? The export performance of multi-product firms on foreign markets," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/330214, Katholieke Universiteit Leuven.

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