IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

Optimal Monetary Policy Rules for the Euro Area: An Analysis Using the Area Wide Model

  • ALISTAIR DIEPPE
  • KEITH KÜSTER
  • PETER McADAM

In this article, we analyse the conduct of optimal monetary policy for the new euro area. The aggregate euro area economy is modelled to have relatively sluggish adjustment properties and a private sector with mainly backward-looking expectations. In this economy, we assume that the central bank searches for its best-performing monetary policy rule, e.g. for the optimal weight to give to inflation stabilization compared to that of output and for the optimal degree of forward-looking in the planning horizon. We first find that the optimal degree of gradualism in interest rate-setting needs only be relatively mild and that the central bank should incorporate new information quickly into policy-making. Second, there is substantial gain from implementing and communicating quite forward-looking policies. The optimal forecast horizon for inflation ranges around six quarters. In contrast to deliberately simple rule-based policy recommendations, fully optimal policy is a complicated response to many different economic indicators. With regard to this we find, third, that optimal policy should be based on a broad information set, even if the resulting policy framework is hard to communicate to the outside world. Thus, the article contributes to the debate on optimal monetary policy for the euro area, as well as to the conduct of monetary policy in face of substantial persistence in the transmission mechanism. Copyright 2005 Blackwell Publishing Ltd.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.0021-9886.2005.00567.x
File Function: link to full text
Download Restriction: Access to full text is restricted to subscribers.

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Wiley Blackwell in its journal Journal of Common Market Studies.

Volume (Year): 43 (2005)
Issue (Month): 3 (09)
Pages: 507-537

as
in new window

Handle: RePEc:bla:jcmkts:v:43:y:2005:i:3:p:507-537
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0021-9886

Order Information: Web: http://www.blackwellpublishing.com/subs.asp?ref=0021-9886

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.:

as in new window
  1. John C. Williams & Andrew T. Levin, 2003. "Robust Monetary Policy with Competing Reference Models," Computing in Economics and Finance 2003 291, Society for Computational Economics.
  2. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  3. Richard Dennis, 2001. "Optimal policy in rational-expectations models: new solution algorithms," Working Paper Series 2001-09, Federal Reserve Bank of San Francisco.
  4. Carsten Detken & Alistair Dieppe & Jér�me Henry & Frank Smets & Carmen Marin, 2002. "Determinants of the Effective Real Exchange Rate of the Synthetic Euro: Alternative Methodological Approaches," Australian Economic Papers, Wiley Blackwell, vol. 41(4), pages 404-436, December.
  5. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," International Tax and Public Finance, Springer, vol. 6(4), pages 537-577, November.
  6. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  7. Gerdesmeier, Dieter & Roffia, Barbara, 2003. "Empirical estimates of reaction functions for the euro area," Working Paper Series 0206, European Central Bank.
  8. Dieppe, Alistair & Henry, Jerome, 2004. "The euro area viewed as a single economy: how does it respond to shocks?," Economic Modelling, Elsevier, vol. 21(5), pages 833-875, September.
  9. Lubik, Thomas A. & Schorfheide, Frank, 2003. "Computing sunspot equilibria in linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 273-285, November.
  10. 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.
  11. Andrew Levin & Volker Wieland & John C. Williams, 1998. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Working Papers 6570, National Bureau of Economic Research, Inc.
  12. Alistair Dieppe & Jerome Henry & Peter Mc Adam, . "Labour market dynamics in the euro area: A model-based sensitivity analysis," Modeling, Computing, and Mastering Complexity 2003 09, Society for Computational Economics.
  13. Williams, John C. & Levin, Andrew T. & Wieland, Volker, 2001. "The performance of forecast-based monetary policy rules under model uncertainty," Working Paper Series 0068, European Central Bank.
  14. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 0042, European Central Bank.
  15. Mankiw, N. Gregory & Reis, Ricardo, 2003. "What Measure of Inflation Should a Central Bank Target?," Scholarly Articles 3415322, Harvard University Department of Economics.
  16. Jeffrey C. Fuhrer, 1995. "The [un]importance of forward-looking behavior in price specifications," Working Papers 95-6, Federal Reserve Bank of Boston.
  17. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
  18. Alex Cukierman, 1989. "Why does the Fed smooth interest rates?," Proceedings, Federal Reserve Bank of St. Louis, pages 111-157.
  19. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
  20. Gerlach, Stefan & Schnabel, Gert, 2000. "The Taylor rule and interest rates in the EMU area," Economics Letters, Elsevier, vol. 67(2), pages 165-171, May.
  21. McAdam, Peter & Hughes Hallett, A J, 1999. " Nonlinearity, Computational Complexity and Macroeconomic Modelling," Journal of Economic Surveys, Wiley Blackwell, vol. 13(5), pages 577-618, December.
  22. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
  23. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  24. Frederico S. Finan & Robert Tetlow, 1999. "Optimal control of large, forward-looking models efficient solutions and two examples," Finance and Economics Discussion Series 1999-51, Board of Governors of the Federal Reserve System (U.S.).
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:bla:jcmkts:v:43:y:2005:i:3:p:507-537. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wiley-Blackwell Digital Licensing)

or (Christopher F. Baum)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.