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An Encompassing Framework For Evaluating Simple Monetary Policy Rules

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Author Info

  • Karen Dury

    (National Institute of Economic and Social Research)

  • Ray Barell

    (National Institute of Economic and Social Research)

  • Ian Hurst

    (National Institute of Economic and Social Research)

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    Abstract

    In this paper we build an encompassing framework to analyse the stability conditions associated with various policy rules. Taylor and others have argued that model stability requires interest rate policy rules to have an inflation feedback parameter greater than one. In a world where there are nominal rigidities in the short-term evolution of demand this may not be the case. We show that with a combined nominal GDP and inflation targeting rule, this stability condition is overly restrictive. We use stochastic simulations to evaluate various monetary policy rules, and parameterisations, that are nested within a general framework. We do this using the National Institutes Global Econometric Model, NiGEM, which combines a neo-classical structure and rational expectations with institutional detail. Our results show that while one rule may be the most effective at stabilising the EMU aggregates, another may be more effective for individual economies, implying a change in the covariance structure of output and inflation within EMU. We discuss the resulting covariance structure and their implications for decision making within the ECB.

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    Bibliographic Info

    Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2000 with number 184.

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    Date of creation: 05 Jul 2000
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    Handle: RePEc:sce:scecf0:184

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    Postal: CEF 2000, Departament d'Economia i Empresa, Universitat Pompeu Fabra, Ramon Trias Fargas, 25,27, 08005, Barcelona, Spain
    Fax: +34 93 542 17 46
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    Web page: http://enginy.upf.es/SCE/
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    References

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    1. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "The Perils of Taylor Rules," CEPR Discussion Papers 2314, C.E.P.R. Discussion Papers.
    2. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
    3. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
    4. Brayton, Flint & Levin, Andrew & Lyon, Ralph & Williams, John C., 1997. "The evolution of macro models at the Federal Reserve Board," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 43-81, December.
    5. Taylor, John B., 1999. "The robustness and efficiency of monetary policy rules as guidelines for interest rate setting by the European central bank," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 655-679, June.
    6. Robert Anderton & Ray Barrell, 1995. "The ERM and structural change in European labour markets: A study of 10 countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 131(1), pages 47-66, March.
    7. Clements,Michael & Hendry,David, 1998. "Forecasting Economic Time Series," Cambridge Books, Cambridge University Press, number 9780521632423, October.
    8. Andrew P. Blake, 1996. "Forecast Error Bounds By Stochastic Simulation," National Institute Economic Review, National Institute of Economic and Social Research, vol. 156(1), pages 72-79, May.
    9. Ray C. Fair, 1998. "Estimated Stabilization Costs of the EMU," National Institute Economic Review, National Institute of Economic and Social Research, vol. 164(1), pages 90-99, April.
    10. Barrell, Ray & Sefton, James, 1997. "Fiscal Policy and the Masstricht Solvency Criteria," The Manchester School of Economic & Social Studies, University of Manchester, vol. 65(3), pages 259-79, June.
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