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Robustifying optimal monetary policy using simple rules as cross-checks

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Author Info

  • Pelin Ilbas

    ()
    (National Bank of Belgium, Research Department)

  • Øistein Røisland

    ()
    (Norges Bank)

  • Tommy Sveen

    ()
    (BI Norwegian Business School)

Abstract

There are two main approaches to modelling monetary policy; simple instrument rules and optimal policy. We propose an alternative that combines the two by extending the loss function with a term penalizing deviations from a simple rule. We analyze the properties of the modified loss function by considering three different models for the US economy. The choice of the weight on the simple rule determines the trade-off between optimality and robustness. We show that placing some weight on a simple Taylor-type rule in the loss function, one can prevent disastrous outcomes if the model is not a correct representation of the underlying economy.

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Bibliographic Info

Paper provided by National Bank of Belgium in its series Working Paper Research with number 245.

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Length: 33 pages
Date of creation: Nov 2013
Date of revision:
Handle: RePEc:nbb:reswpp:201311-245

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Related research

Keywords: Model uncertainty; Optimal control; Simple rules;

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Cited by:
  1. Bursian, Dirk & Roth, Markus, 2013. "Optimal policy and taylor rule cross-checking under parameter uncertainty," SAFE Working Paper Series 30, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  2. Winkelried, Diego, 2013. "Modelo de Proyección Trimestral del BCRP: Actualización y novedades," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 26, pages 9-60.

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