Robustifying optimal monetary policy using simple rules as cross-checks
AbstractThere 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 InfoPaper provided by National Bank of Belgium in its series Working Paper Research with number 245.
Length: 33 pages
Date of creation: Nov 2013
Date of revision:
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Model uncertainty; Optimal control; Simple rules;
Other versions of this item:
- Pelin Ilbas & Øistein Røisland & Tommy Sveen, 2012. "Robustifying optimal monetary policy using simple rules as cross-checks," Working Paper 2012/22, Norges Bank.
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-11-22 (All new papers)
- NEP-CBA-2013-11-22 (Central Banking)
- NEP-MAC-2013-11-22 (Macroeconomics)
- NEP-MON-2013-11-22 (Monetary Economics)
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- 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.
- 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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