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Optimal Taylor Rules in an Estimated Model of a Small Open Economy

  • Nooman Rebei
  • Steve Ambler
  • Ali Dib

We develop a model of a small open economy with three types of nominal rigidities (domestic goods prices, imported goods prices and wages) and eight different structural shocks. We estimate the model's structural parameters using a maximum likelihood procedure and use it to compute welfare-maximizing Taylor rules for setting domestic short-term interest rates. For these computations, we use a second-order approximation around the model's deterministic steady state, which allows the Taylor rule coefficients to affect the means of consumption, leisure and real balances as well as their variances. Welfare gains from moving to the optimal Taylor rule are substantial, but require a very precise knowledge of the values of the model's structural parameters.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 125.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:125
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