Robustifying optimal monetary policy using simple rules as cross-checks
There are two main approaches to modelling monetary policy; simple instrument rules and optimal policy. We propose an alternative that combines the two by extending the loss function with a term penalizing deviations from a simple rule. We analyze the properties of the modified loss function by considering three different models for the US economy. The choice of the weight on the simple rule determines the trade-off between optimality and robustness. We show that by placing some weight on a simple Taylor-type rule in the loss function, one can prevent disastrous outcomes if the model is not a correct representation of the underlying economy.
|Date of creation:||18 Dec 2012|
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- Taylor, John B. & Wieland, Volker, 2012.
"Surprising comparative properties of monetary models: Results from a new model database,"
IMFS Working Paper Series
66, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
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Elsevier, vol. 117(1), pages 204-207.
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Handbook of Monetary Economics,
in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 22, pages 1237-1302
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"Simple and robust rules for monetary policy,"
Working Paper Series
2010-10, Federal Reserve Bank of San Francisco.
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