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Assessing simple policy rules: A view from a complete macroeconomic model

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  • Eric M. Leeper
  • Tao Zha

Abstract

Monetary policy analysts looking for a model on which to base decisions may consider two popular approaches-the New Keynesian (NK) and the identified vector autoregression (VAR) approaches. Choosing between the two can be difficult: NK models are stylized and have simple rules while structural VAR models have complex dynamics and loose behavioral interpretations. ; The simpler NK models often produce stark conclusions. For example, NK analyses consistently find that the Federal Reserve's monetary policy has improved markedly in the past two decades compared with the 1960s and 1970s. In contrast, VARs find little instability in the policy parameters or in the dynamic impacts of exogenous shifts in policy. ; Taking the view that NK models are simply restricted VARs, the authors estimate systems of structural equations implied by NK models. They find that these estimated equations vary considerably over different periods. The authors also investigate the role of money by incorporating money (M2) into the NK model; they find that including money substantially alters the model's conclusions about monetary policy. This result conflicts with the NK theoretical assumption that money is irrelevant. ; Both NK models and VARs have their place in policy advising, the authors believe. But they caution that it is treacherous to draw inferences about policy effects solely from policy rules estimated in isolation from a complete macro model.

Suggested Citation

  • Eric M. Leeper & Tao Zha, 2001. "Assessing simple policy rules: A view from a complete macroeconomic model," Economic Review, Federal Reserve Bank of Atlanta, issue Q4, pages 35-58.
  • Handle: RePEc:fip:fedaer:y:2001:i:q4:p:35-58:n:v.86no.4
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