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The Optimality of the US and Euro Area Taylor Rule

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Author Info
Ferhat MIHOUBI
Pascal JACQUINOT
Abstract

The purpose of this paper is to examine the optimality of the monetary authorities reaction function in the two-area medium size model MARCOS (US and euro areas). The parameters and the horizons of output gap and inflation expectations of the Taylor rule are computed in order to minimise a loss function of the monetary authorities. However, investigating the optimality of the Taylor rule in the context of a large scale macroeconomic model raises several difficulties: the model is non-linear and all the state variables potentially enter the optimal monetary policy rule. Furthermore, the optimality of the Taylor rule is assessed by the minimisation of the loss function under the constraint of a large forward-looking model. To overcome these problems, Black, Macklem and Rose [1998] propose a stochastic simulation based method which has been applied to single-country macroeconomic models. To study the optimality of the Taylor rule in the case of a two-area model, we suppose that the economy is stochastically hit by numerous shocks (supply, demand, monetary, exchange rate and world demand) in each area and simulate MARCOS stochastically.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 220.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:220

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Related research
Keywords: Monetary Policy; Computational Techniques; International Policy Transmission;

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
C63 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Computational Techniques
F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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    Other versions:
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    Other versions:
  3. Drew, Aaron & Hunt, Benjamin, 2000. "Efficient simple policy rules and the implications of potential output uncertainty," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 143-160. [Downloadable!] (restricted)
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  4. Nicoletta Batini & Edward Nelson, . "Optimal horizons for inflation targeting," Bank of England working papers 119, Bank of England. [Downloadable!]
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  5. 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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  6. Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies. [Downloadable!]
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  7. Hamid Faruqee & Peter Isard & Douglas Laxton & Eswar Prasad & Bart Turtelboom, 1998. "Multimod Mark III: The Core Dynamic and Steady State Model," IMF Occasional Papers 164, International Monetary Fund. [Downloadable!]
  8. Hamid Faruqee & Douglas Laxton & Steven A. Symansky, 1996. "Government Debt, Life-Cycle Income and Liquidity Constrains: Beyond Approximate Ricardian Equivalence," IMF Working Papers 96/140, International Monetary Fund.
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