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Modeling and identifying central banks' preferences

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  • Carlo A. Favero
  • Riccardo Rovelli

Abstract

In this paper we propose an approach to identify indipendently the parameters describing the structure of the economy from the parameters describing central bank preferences. We first estimate the parameters describing the structure of the US economy by considering a parsimonious specification for inflation, the output-gap and the commodity price index. We then proceed to the identification of central bank preferences by estimating by GMM the Euler equations for the solution of the intertemporal optimization problem relevant to the central banker. We then compare optimal and actual interest rate behavior to select a structure of central bank's preferences. Our main results are as follows. First, persistence in interest rates could be explained by the structure of the economy. Second, "strict" inflation targeting dominates "flexible" inflation targeting. Third, the actual behavior of the policy rates cannot be described by the pure "strict" inflation targeting model, which would imply a much more aggressive monetary policy than the observed one. Fourth, when the inflation targeting model is extended to consider Brainard-type uncertainty and real interest rates smoothing, the latter is preferred hypothesis to reconcile actual and optimal interest rates behavior.

Suggested Citation

  • Carlo A. Favero & Riccardo Rovelli, "undated". "Modeling and identifying central banks' preferences," Working Papers 148, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  • Handle: RePEc:igi:igierp:148
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    References listed on IDEAS

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    Cited by:

    1. Anton Muscatelli & Patrizio Tirelli & Carmine Trecroci, 2001. "Monetary and Fiscal Policy Interactions over the Cycle: Some Empirical Evidence," Working Papers 2002_13, Business School - Economics, University of Glasgow, revised Oct 2002.
    2. Saint-Paul, G. & Bentolila, S., 2000. "Will EMU Increase Eurosclerosis?," Papers 0004, Centro de Estudios Monetarios Y Financieros-.
    3. Brzozowski, Michal, 2004. "Identifying central bank’s preferences: the case of Poland," Working Papers in Economics 143, University of Gothenburg, Department of Economics.
    4. Marco Buti & Martin Larch & Fabio Balboni, 2009. "Monetary and fiscal policy interactions in the EMU when cyclical conditions are uncertain," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 36(1), pages 21-44, February.
    5. Jerry Coakley & Ana-Maria Fuertes, 2002. "Asymmetric dynamics in UK real interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 12(6), pages 379-387.
    6. Stefan Krause & Fabio Méndez, 2005. "Policy Makers' Preferences, Party Ideology, and the Political Business Cycle," Southern Economic Journal, Southern Economic Association, vol. 71(4), pages 752-767, April.
    7. Stefan Krause, 2007. "Measuring Monetary Policy Efficiency in European Union Countries: The Pre-EMU Years," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(1), pages 60-83, February.
    8. Helge Berger & Ulrich Woitek, "undated". "Does Conservatism Matter? A Time Series Approach to Central Banking," Working Papers 9814, Business School - Economics, University of Glasgow, revised May 1999.
    9. Rotondi, Zeno, 2000. "Designing instrument rules for monetary stability: the optimality of interest-rate smoothing," Discussion Paper Series In Economics And Econometrics 0008, Economics Division, School of Social Sciences, University of Southampton.
    10. Muscatelli, Anton & Trecroci, Carmine, 2000. " Monetary Policy Rules, Policy Preferences, and Uncertainty: Recent Empirical Evidence," Journal of Economic Surveys, Wiley Blackwell, vol. 14(5), pages 597-627, December.
    11. Muscatelli, V Anton & Tirelli, Patrizio & Trecroci, Carmine, 2002. "Does Institutional Change Really Matter? Inflation Targets, Central Bank Reform and Interest Rate Policy in the OECD Countries," Manchester School, University of Manchester, vol. 70(4), pages 487-527, Special I.
    12. Marc-Alexandre Sénégas, 2002. "La politique monétaire face à l'incertitude : un survol méthodologique des contributions relatives à la zone euro," Revue d'Économie Financière, Programme National Persée, vol. 65(1), pages 177-200.
    13. Fabio Balboni & Marco Buti & Martin Larch, 2007. "ECB vs Council vs Commission: Monetary and fiscal policy interactions in the EMU when cyclical conditions are uncertain," European Economy - Economic Papers 2008 - 2015 277, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    14. Karsten Ruth, 2007. "Interest rate reaction functions for the euro area," Empirical Economics, Springer, vol. 33(3), pages 541-569, November.
    15. Ruth, Karsten, 2004. "Interest rate reaction functions for the euro area Evidence from panel data analysis," Discussion Paper Series 1: Economic Studies 2004,33, Deutsche Bundesbank.
    16. Xavier Debrun, 2000. "Fiscal Rules in a Monetary Union: A Short-Run Analysis," Open Economies Review, Springer, vol. 11(4), pages 323-358, October.

    More about this item

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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