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Robust Inflation-Targeting Rules and the Gains from International Policy Coordination

  • Paul Levine

    (University of Surrey)

  • Joseph Pearlman

    (London Metropolitan University)

  • Peter Welz

    (Sveriges Riksbank)

This paper empirically assesses the performance of interest-rate monetary rules for interdependent economies characterized by model uncertainty. We set out a two-bloc dynamic stochastic general equilibrium model with habit persistence (that generates output persistence), Calvo pricing and wage-setting with indexing of non-optimized prices and wages (generating inflation persistence), incomplete financial markets and the incomplete pass-through of exchange rate changes. We estimate a linearized form of the model by Bayesian maximum-likelihood methods using US and Euro-zone data. From the estimates of the posterior distributions we then examine monetary policy conducted both independently and cooperatively by the Fed and the ECB in the form of robust inflation-targeting interest-rate rules. Comparing the utility outcome in a closed-loop Nash equilibrium with the outcome from a coordinated design of policy rules, we find a new result: the gains from monetary policy coordination rise significantly when CPI inflation targeting interest-rate rules are designed to account for model uncertainty.

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File URL: http://www.fahs.surrey.ac.uk/economics/discussion_papers/2008/DP02-08.pdf
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Paper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 0208.

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Length: 52 pages
Date of creation: Jan 2008
Date of revision:
Handle: RePEc:sur:surrec:0208
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