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Inferring policy objectives from economic outcomes

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  • Richard Dennis

Abstract

This paper stresses that estimated policy rules are reduced form equations that are silent on many important policy questions. To obtain a structural understanding of monetary policy it is necessary to estimate the policymaker's objective function, rather than its policy reaction function. With these issues in mind, this paper proposes a system-based estimation approach that uses the solution to the policymaker's optimization problem to infer the underlying policy regime from the economy's evolution over time. The paper derives conditions under which the parameters in a policymaker's policy objective function can be identified and estimated. These identification conditions apply to forward-looking rational-expectations models as well as to backward-looking models, extending existing results. We apply these conditions to a New Keynesian sticky-price model of the US economy, estimating jointly all of the model's behavioral parameters and the policy regime parameters. The results show that the implicit inflation target and the relative weight placed on interest rate smoothing both declined with Volcker's appointment to Federal Reserve chairman. However, the estimates reveal that other - non-monetary-policy - parameters have changed over time also.

Suggested Citation

  • Richard Dennis, 2003. "Inferring policy objectives from economic outcomes," Working Paper Series 2003-05, Federal Reserve Bank of San Francisco, revised 2003.
  • Handle: RePEc:fip:fedfwp:2003-05
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    Citations

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    Cited by:

    1. Richard Dennis, 2008. "Timeless perspective policymaking: When is discretion superior?," Working Paper Series 2008-21, Federal Reserve Bank of San Francisco, revised 2008.
    2. Glenn Otto & Graham Voss, 2009. "Strict and Flexible Inflation Forecast Targets: An Empirical Investigation," Department Discussion Papers 0902, Department of Economics, University of Victoria.
    3. Richard Dennis, 2006. "The policy preferences of the US Federal Reserve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 55-77.
    4. Gregory E. Givens, 2012. "Estimating Central Bank Preferences under Commitment and Discretion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(6), pages 1033-1061, September.
    5. Martin Mandler, 2010. "Explaining ECB and FED interest rate correlation: Economic interdependence and optimal monetary policy," MAGKS Papers on Economics 201025, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    6. Pelin Ilbas, 2012. "Revealing the preferences of the US Federal Reserve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 27(3), pages 440-473, April.
    7. Pardo, S. & Rautureau, N. & Vallée, T., 2011. "Optimal versus realized policy rules in a regime-switching framework," Economic Modelling, Elsevier, vol. 28(6), pages 2761-2775.
    8. Madhavi Bokil, 2005. "Fear of Floating: An optimal discretionary monetary policy analysis," International Finance 0510002, University Library of Munich, Germany.
    9. Cabrera, Nilda & Bejarano, Edilean & Savino Portugal, Marcelo, 2011. "Preferences of the Central Reserve Bank of Peru and optimal monetary policy rules in the inflation targeting regime," Working Papers 2011-010, Banco Central de Reserva del Perú.

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