IDEAS home Printed from https://ideas.repec.org/p/sce/scecf9/1153.html
   My bibliography  Save this paper

The Performance of Forward-Looking Monetary Policy Rules under Model Uncertainty

Author

Listed:
  • Volker Wieland

    () (Federal Reserve Board)

  • Andrew Levin

    () (Federal Reserve Board)

  • John C. Williams

    () (Federal Reserve Board)

Abstract

Recently, increasing attention is being devoted to interest rate rules that respond directly to economic forecasts rather than relying on current and past observations. Empirical studies suggest this 'forward-looking' rule provides a reasonable description of recent monetary policy in several industrial countries. Such rules are also advocated on analytical grounds including simplicity, transparency, and efficiency. But, such rules can fail to generate unique rational expectations equilibrium under various combinations of structural and policy parameters, raising concerns whether forward-looking rules are robust to model uncertainty. Here, we analyze the efficiency and robustness of forward-looking rules using four structural macroeconometric models of the U.S. economy: the Fuhrer-Moore model, Taylor's Multi-Country Model, the MSR model of Orphanides and Wieland, and the FRB staff model. All four incorporate assumptions of rational expectations, short-run nominal inertia, and long-run monetary neutrality, but differ in other respects such as real expenditures and the dynamics of prices. We assume a policy objective of minimizing a weighted sum of the unconditional variances of the inflation rate, the output gap, and federal funds rate changes. For given model and particular class of policy rules, we determine the region of the parameter space for which simple forward-looking and backward-looking rules generate unique equilibria. Within this region, we determine the performance of rules on the policy frontier -- the best obtainable outcomes for output, inflation, and funds-rate volatilities. Finally, we evaluate robustness to model uncertainty, taking rules that perform well in one model and assessing their performance in each of the other three. Our analysis yields three significant conclusions. First, the indeterminacy problem is not one of practical concern. All four models exhibit a relatively high degree of nominal and real inertia consistent with U.S. data. Second, in each model, we find that forward-looking rules provide negligible stabilization benefits compared with well-designed backward-looking rules. Finally, the forward-looking rules that perform well in one model often perform very poorly in the other three. By contrast, simple backward-looking rules taken from the policy frontier of one model are generally very close to the frontier in each of the other three. Thus, while small improvements in output and inflation variability can sometimes be obtained using forward-looking rules, we find them to be much less robust to model uncertainty than simple backward-looking rules.

Suggested Citation

  • Volker Wieland & Andrew Levin & John C. Williams, 1999. "The Performance of Forward-Looking Monetary Policy Rules under Model Uncertainty," Computing in Economics and Finance 1999 1153, Society for Computational Economics.
  • Handle: RePEc:sce:scecf9:1153
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Citations

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


    Cited by:

    1. Keith Kuester & Volker Wieland, 2010. "Insurance Policies for Monetary Policy in the Euro Area," Journal of the European Economic Association, MIT Press, vol. 8(4), pages 872-912, June.
    2. Roberts John M., 2005. "How Well Does the New Keynesian Sticky-Price Model Fit the Data?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-39, September.
    3. Tetlow, Robert J. & von zur Muehlen, Peter, 2009. "Robustifying learnability," Journal of Economic Dynamics and Control, Elsevier, vol. 33(2), pages 296-316, February.
    4. Amman, Hans M. & Kendrick, David A., 2003. "Mitigation of the Lucas critique with stochastic control methods," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11-12), pages 2035-2057, September.
    5. Richard Dennis, 2003. "Exploring the Role of the Real Exchange Rate in Australian Monetary Policy," The Economic Record, The Economic Society of Australia, vol. 79(244), pages 20-38, March.
    6. Kendrick, David A., 2005. "Stochastic control for economic models: past, present and the paths ahead," Journal of Economic Dynamics and Control, Elsevier, vol. 29(1-2), pages 3-30, January.

    More about this item

    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:sce:scecf9:1153. 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: (Christopher F. Baum). General contact details of provider: http://edirc.repec.org/data/sceeeea.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.

    We have no references for this item. You can help adding them by using 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.