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Monetary Policy with a Wider Information Set: a Bayesian Model Averaging Approach

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Author Info

  • Fabio Milani

    (Princeton University)

Abstract

Monetary policy has been usually analyzed in the context of small macroeconomic models where central banks are allowed to exploit a limited amount of information. Under these frameworks, researchers typically derive the optimality of aggressive monetary rules, contrasting with the observed policy conservatism and interest rate smoothing. This paper allows the central bank to exploit a wider information set, while taking into account the associated model uncertainty, by employing Bayesian Model Averaging with Markov Chain Model Composition (MC³). In this enriched environment, we derive the optimality of smoother and more cautious policy rates, together with clear gains in macroeconomic efficiency.

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File URL: http://128.118.178.162/eps/mac/papers/0401/0401004.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0401004.

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Length: 43 pages
Date of creation: 18 Jan 2004
Date of revision:
Handle: RePEc:wpa:wuwpma:0401004

Note: Type of Document - pdf; prepared on Win2000; pages: 43; figures: included
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Web page: http://128.118.178.162

Related research

Keywords: Bayesian model averaging; leading indicators; model uncertainty; optimal monetary policy; interest rate smoothing.;

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References

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  1. Svensson, Lars E. O. & Woodford, Michael, 2003. "Indicator variables for optimal policy," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 691-720, April.
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  8. Onatski, Alexei & Stock, James H., 2002. "Robust Monetary Policy Under Model Uncertainty In A Small Model Of The U.S. Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 85-110, February.
  9. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  10. Favero, Carlo A & Milani, Fabio, 2005. "Parameter Instability, Model Uncertainty and the Choice of Monetary Policy," CEPR Discussion Papers 4909, C.E.P.R. Discussion Papers.
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  16. repec:cup:macdyn:v:6:y:2002:i:1:p:85-110 is not listed on IDEAS
  17. Carmen Fernandez & Eduardo Ley & Mark Steel, 1999. "Model uncertainty in cross-country growth regressions," Econometrics 9903003, EconWPA, revised 06 Oct 2001.
  18. Ben S. Bernanke & Jean Boivin, 2001. "Monetary Policy in a Data-Rich Environment," NBER Working Papers 8379, National Bureau of Economic Research, Inc.
  19. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  20. Fabio Milani, 2003. "Adaptive Learning, Model Uncertainty and Monetary Policy Inertia in a Large Information Environment," Computing in Economics and Finance 2003 280, Society for Computational Economics.
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Citations

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Cited by:
  1. Arnulfo Rodríguez & Pedro N. Rodríguez, 2007. "Recursive Thick Modeling and the Choice of Monetary Policy in Mexico," Working Papers 2007-04, Banco de México.
  2. Zampolli, Fabrizio, 2006. "Optimal monetary policy in a regime-switching economy: The response to abrupt shifts in exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1527-1567.
  3. Arnulfo Rodríguez & Fidel González & Jesús R. González García, 2007. "Uncertainty about the Persistence of Cost-Push Shocks and the Optimal Reaction of the Monetary Authority," Working Papers 2007-05, Banco de México.
  4. Maltritz, Dominik, 2012. "Determinants of sovereign yield spreads in the Eurozone: A Bayesian approach," Journal of International Money and Finance, Elsevier, vol. 31(3), pages 657-672.
  5. Fabrizio Zampolli, 2004. "Optimal monetary policy in a regime-switching economy," Computing in Economics and Finance 2004 166, Society for Computational Economics.
  6. Garett Jones & W. Schneider, 2006. "Intelligence, Human Capital, and Economic Growth: A Bayesian Averaging of Classical Estimates (BACE) Approach," Journal of Economic Growth, Springer, vol. 11(1), pages 71-93, 03.
  7. Gonzalez F. & Rodriguez A. & Gonzalez-Garcia J.R., 2005. "Uncertainty about the Persistence of Periods with Large Price Shocks and the Optimal Reaction of the Monetary Authority," Computing in Economics and Finance 2005 402, Society for Computational Economics.
  8. Maltritz, Dominik & Molchanov, Alexander, 2013. "Analyzing determinants of bond yield spreads with Bayesian Model Averaging," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5275-5284.
  9. Arnulfo Rodriguez & Pedro N. Rodriguez, 2006. "Recursive Thick Modeling and the Choice of Monetary Policy in Mexico," Computing in Economics and Finance 2006 30, Society for Computational Economics.

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