A close look at model-dependent monetary policy design

This article first explores the implications of model specification on the design of targeting rules in a world of model certainty. As a general prescription, a targeting rule must counterbalance the private-sector dynamics: The more backward-looking behavior is observed in either the output gap or inflation, the more forward-looking monetary policy should be. Likewise, a more forward-looking economy would require stronger backward-looking reactions of the nominal interest rate to the output gap or inflation. The article also analyzes the effects of implementing monetary policy in an environment with uncertainty. Our results indicate that a simple model-invariant rule of the style proposed by Taylor (1993) performs better than a model-dependent targeting rule in the presence of moderate parameter uncertainty.