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 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.
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- John B. Taylor & John C. Williams, 2010.
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Working Paper Series
2010-10, Federal Reserve Bank of San Francisco.
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IMFS Working Paper Series
66, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
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MAGKS Papers on Economics
201132, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
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NBER Working Papers
16654, National Bureau of Economic Research, Inc.
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