IDEAS home Printed from https://ideas.repec.org/p/hhs/osloec/2007_014.html
   My bibliography  Save this paper

Model selection for monetary policy analysis How important is empirical validity?

Author

Listed:
  • Akram, Q. Farooq

    (Research Department, Norges Bank)

  • Nymoen, Ragnar

    () (Dept. of Economics, University of Oslo)

Abstract

We investigate the economic significance of trading off empirical validity of models against other desirable model properties, and the potential loss from ’overestimating’ model uncertainty and basing monetary policy on a relatively robust model, or on a suite of models. We find that differences in model specification and even differences in estimates of key parameters across comparable models may entail widely different monetary policy and macroeconomic performance. Our results therefore caution against compromising the empirical validity of models when selecting a model for policy analysis. We also find that potential costs from basing monetary policies on the relatively robust model or on a suite of models, even when it contains the valid model by assumption, can be quite substantial. This suggests huge gains from efficient exploitation of available information sources to avoid overestimation of model uncertainty. Our investigation is based on three alternative econometric systems of wage and price inflation for Norway

Suggested Citation

  • Akram, Q. Farooq & Nymoen, Ragnar, 2007. "Model selection for monetary policy analysis How important is empirical validity?," Memorandum 14/2007, Oslo University, Department of Economics.
  • Handle: RePEc:hhs:osloec:2007_014
    as

    Download full text from publisher

    File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2007/Memo-14-2007.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Leeper, Eric M. & Zha, Tao, 2003. "Modest policy interventions," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1673-1700, November.
    2. Robert J. Gordon, 1997. "The Time-Varying NAIRU and Its Implications for Economic Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 11-32, Winter.
    3. Elena Andreou & Aris Spanos, 2003. "Statistical Adequacy and the Testing of Trend Versus Difference Stationarity," Econometric Reviews, Taylor & Francis Journals, vol. 22(3), pages 217-237, January.
    4. Stock, James H. & Watson, Mark W., 1999. "Forecasting inflation," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 293-335, October.
    5. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228.
    6. Nymoen, Ragnar, 1989. " Wages and the Length of the Working Day. An Empirical Test Based on Norwegian Quarterly Manufacturing Data," Scandinavian Journal of Economics, Wiley Blackwell, vol. 91(3), pages 599-612.
    7. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters,in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
    8. Bardsen, Gunnar & Eitrheim, Oyvind & Jansen, Eilev S. & Nymoen, Ragnar, 2005. "The Econometrics of Macroeconomic Modelling," OUP Catalogue, Oxford University Press, number 9780199246502.
    9. Godfrey, Leslie G, 1978. "Testing for Higher Order Serial Correlation in Regression Equations When the Regressors Include Lagged Dependent Variables," Econometrica, Econometric Society, vol. 46(6), pages 1303-1310, November.
    10. Hoover,Kevin D., 2001. "Causality in Macroeconomics," Cambridge Books, Cambridge University Press, number 9780521002882, October.
    11. Jon Faust & Dale W. Henderson, 2004. "Is inflation targeting best-practice monetary policy?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 117-144.
    12. Granger, Clive W. J., 1992. "Fellow's opinion: Evaluating economic theory," Journal of Econometrics, Elsevier, vol. 51(1-2), pages 3-5.
    13. Hansen, Lars-Peter & Sargent, Thomas-J, 2001. "Acknowledgement Misspecification in Macroeconomic Theory," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 213-227, February.
    14. Driffill, John & Rotondi, Zeno, 2004. "Monetary Policy and Lexicographic Preference Ordering," CEPR Discussion Papers 4247, C.E.P.R. Discussion Papers.
    15. Batini, Nicoletta & Nelson, Edward, 2001. "Optimal horizons for inflation targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 891-910, June.
    16. Mankiw, N Gregory, 1989. "Real Business Cycles: A New Keynesian Perspective," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 79-90, Summer.
    17. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 537-577, November.
    18. Rudebusch, Glenn D, 2005. "Assessing the Lucas Critique in Monetary Policy Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 245-272, April.
    19. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
    20. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2003. "Econometric inflation targeting," Econometrics Journal, Royal Economic Society, vol. 6(2), pages 430-461, December.
    21. Granger, Clive W. J., 2001. "Macroeconometrics - Past and future," Journal of Econometrics, Elsevier, vol. 100(1), pages 17-19, January.
    22. Johansen, Kare, 1995. "Norwegian Wage Curves," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 57(2), pages 229-247, May.
    23. Nymoen, R, 1991. "A Small Linear Model of Wage- and Price-Inflation in the Norwegian Economy," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 6(3), pages 255-269, July-Sept.
    24. Neil R. Ericsson & John S. Irons, 1995. "The Lucas critique in practice: theory without measurement," International Finance Discussion Papers 506, Board of Governors of the Federal Reserve System (U.S.).
    25. Timothy Cogley & Thomas J. Sargent, 2005. "The conquest of US inflation: Learning and robustness to model uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 528-563, April.
    26. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    27. Bardsen, G. & Fisher, P.G. & Nymoen, R., 1994. "Business Cycles: Real Facts or Fallacies?," Papers 20-94, Norwegian School of Economics and Business Administration-.
    28. Q. Farooq Akram & Gunnar Bärdsen & Øyvind Eitrheim, 2006. "Monetary policy and asset prices: to respond or not?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(3), pages 279-292.
    29. Laurence H. Meyer, 2004. "Practical problems and obstacles to inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 151-160.
    30. Lars Peter Hansen & Thomas J. Sargent, 2001. "Acknowledging Misspecification in Macroeconomic Theory," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 519-535, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Mardi Dungey & M.Tugrul Vehbi, 2011. "A SVECM Model of the UK Economy and The Term Premium," CAMA Working Papers 2011-26, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    2. Jennifer Castle & David Hendry, 2016. "Policy Analysis, Forediction, and Forecast Failure," Economics Series Working Papers 809, University of Oxford, Department of Economics.
    3. Skrove Falch, Nina & Nymoen, Ragnar, 2011. "The accuracy of a forecast targeting central bank," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 5, pages 1-36.
    4. repec:gam:jecnmx:v:5:y:2017:i:3:p:39-:d:110547 is not listed on IDEAS
    5. Dungey, Mardi & Vehbi, Tugrul, 2015. "The influences of international output shocks from the US and China on ASEAN economies," Journal of Asian Economics, Elsevier, vol. 39(C), pages 59-71.
    6. repec:wly:jforec:v:36:y:2017:i:6:p:629-639 is not listed on IDEAS
    7. Gunnar Bårdsen & Dag Kolsrud & Ragnar Nymoen, 2017. "Forecast robustness in macroeconometric models," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 36(6), pages 629-639, September.
    8. Ragnar Nymoen, 2017. "Between Institutions and Global Forces: Norwegian Wage Formation Since Industrialisation," Econometrics, MDPI, Open Access Journal, vol. 5(1), pages 1-54, January.
    9. Bårdsen, Gunnar & den Reijer, Ard & Jonasson, Patrik & Nymoen, Ragnar, 2012. "MOSES: Model for studying the economy of Sweden," Economic Modelling, Elsevier, vol. 29(6), pages 2566-2582.

    More about this item

    Keywords

    Model uncertainty; Economic significance; Econometric modelling;

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hhs:osloec:2007_014. 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: (Mari Strønstad Øverås). General contact details of provider: http://edirc.repec.org/data/souiono.html .

    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 CitEc recognized a reference but did not link an item in RePEc 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.