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Optimal Constrained Interest Rate Rules

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Author Info
Bruce McGough
George Evans

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Abstract

The monetary policy literature has recently devoted considerable attention to Taylor-type rules, in which the interest rate set by the central bank depends on measures of inflation and aggregate output. We show that if policy-makers attempt to choose the optimal rule within a Taylor-type class they may be led to rules that generate indeterminacy and/or instability under learning. This problem is compounded by uncertainty about structural parameters. We advocate a procedure in which policy-makers restrict attention to rules that lie in the determinate stable region for all plausible calibrations, and which minimize the expected loss, computed using structural parameter priors, subject to this constraint

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Publisher Info
Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 134.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:134

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Related research
Keywords: Monetary Policy; Taylor Rules; Indeterminacy; E-stability; parameter uncertainty; robust rules.;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Evans, George W. & McGough, Bruce, 2005. "Stable sunspot solutions in models with predetermined variables," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 601-625, April. [Downloadable!] (restricted)
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  2. Evans, George W. & Honkapohja, Seppo, 2003. "Existence of adaptively stable sunspot equilibria near an indeterminate steady state," Journal of Economic Theory, Elsevier, vol. 111(1), pages 125-134, July. [Downloadable!] (restricted)
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  3. Nicoletta Batini & Alejandro Justiniano & Paul Levine & Joseph Pearlman, 2004. "Robust Inflation-Forecast-Based Rules to Shield against Indeterminacy," Department of Economics Discussion Papers 0804, Department of Economics, University of Surrey. [Downloadable!]
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  4. Woodford, Michael, 1990. "Learning to Believe in Sunspots," Econometrica, Econometric Society, vol. 58(2), pages 277-307, March. [Downloadable!] (restricted)
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  5. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen. [Downloadable!] (restricted)
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  6. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
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  7. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis. [Downloadable!]
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  8. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
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  9. Vitor Gaspar & Frank Smets, 2005. "Monetary Policy under Adaptive Learning," Computing in Economics and Finance 2005 80, Society for Computational Economics. [Downloadable!]
  10. Honkapohja, Seppo & Mitra, Kaushik, 2004. "Are non-fundamental equilibria learnable in models of monetary policy?," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1743-1770, November. [Downloadable!] (restricted)
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  11. Bennett T. McCallum & Edward Nelson, 1998. "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," NBER Working Papers 6599, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September. [Downloadable!] (restricted)
  13. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules under Model Uncertainty," CFS Working Paper Series 2003/06, Center for Financial Studies. [Downloadable!]
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  14. Evans, George W & Honkapohja, Seppo, 2002. "Monetary Policy, Expectations and Commitment," CEPR Discussion Papers 3434, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  15. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," Levine's Bibliography 506439000000000394, UCLA Department of Economics. [Downloadable!]
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  16. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  17. Evans, George W. & McGough, Bruce, 2005. "Monetary policy, indeterminacy and learning," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1809-1840, November. [Downloadable!] (restricted)
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  18. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 581-604, April. [Downloadable!] (restricted)
  20. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
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  22. Athanasios Orphanides amd John Williams, 2001. "Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2001 254, Society for Computational Economics.
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  23. Jess Benhabib & Stefano Eusepi, 2005. "The design of monetary and fiscal policy: a global perspective," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
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  24. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
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  25. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
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  26. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Blackwell Publishing, vol. 70(4), pages 807-824, October. [Downloadable!] (restricted)
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  27. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  28. Svensson, Lars E O & Woodford, Michael, 2004. "Implementing Optimal Policy Through Inflation-Forecast Targeting," CEPR Discussion Papers 4229, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  29. James Bullard & Kaushik Mitra, 2003. "Determinacy, learnability, and monetary policy inertia," Working Papers 2000-030, Federal Reserve Bank of St. Louis. [Downloadable!]
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  30. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Sticky price models of the business cycle: can the contract multiplier solve the persistence problem?," Staff Report 217, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  31. repec:att:wimass:1920315 is not listed on IDEAS
  32. Honkapohja, Seppo & Mitra, Kaushik, 2005. "Performance of monetary policy with internal central bank forecasting," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 627-658, April. [Downloadable!] (restricted)
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  33. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Macroeconomics 0510022, EconWPA. [Downloadable!]
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  34. Vitor Gaspar & Frank Smets & David Vestin, 2006. "Optimal Monetary Policy under Adaptive Learning," Computing in Economics and Finance 2006 183, Society for Computational Economics. [Downloadable!]
  35. Taylor, John B, 1977. "Conditions for Unique Solutions in Stochastic Macroeconomic Models with Rational Expectations," Econometrica, Econometric Society, vol. 45(6), pages 1377-85, September. [Downloadable!] (restricted)
  36. Evans George W. & Honkapohja Seppo, 1994. "On the Local Stability of Sunspot Equilibria under Adaptive Learning Rules," Journal of Economic Theory, Elsevier, vol. 64(1), pages 142-161, October. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Evans , George W & Honkapohja, Seppo, 2007. "Expectations, learning and monetary policy: an overview of recent research," Research Discussion Papers 32/2007, Bank of Finland. [Downloadable!]
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