Robustifying Optimal Monetary Policy Using Simple Rules as Cross-Checks

Ilbas, Pelin; Røisland, Øistein; Sveen, Tommy

doi:10.2139/ssrn.2269236

Cited by 25 publications

(20 citation statements)

References 25 publications

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“…However, there is a misspecification on the side of the model parameters as the monetary authority is not able to perfectly estimate all of them. This approach is realistic in the sense that we do not believe the monetary authority (at least in the long run) to get it wrong in terms of the reference model which is the basic implication of Ilbas et al (2012).…”

Section: The Conduct Of Monetary Policymentioning

confidence: 99%

“…Inspired by Ilbas et al (2012), we augment the standard loss function (1) by a cross-checking term representing the squared interest rate spread and a corresponding weighting parameter λ ∆ . Hence,…”

Section: The Conduct Of Monetary Policymentioning

confidence: 99%

“…This enables the monetary authority, compared to a discretionary policy maker, to obtain lower future losses at the cost of higher losses today. The commitment case is useful in order to isolate the effects of Taylor rule cross-checking from that of lack of credibility and makes results comparable to Ilbas et al (2012) where a commitment technology is available to the monetary authority. We additionally consider the discretionary case and employ numerical approaches in order to calculate both optimal policies.…”

Section: The Conduct Of Monetary Policymentioning

confidence: 99%

“…Ilbas et al (2012) show in a different setting that the Taylor rule can robustify monetary policy in case of model uncertainty, in other words in the case of a complete mismatch between the model that the monetary authority uses in order to determine its monetary policy and the true model and therefore the data generating process of the economy. They find that in such a framework, even putting a small weight on the information resulting from Taylor rule cross-checking in the process of the determination of optimal monetary policy is able to insure against bad outcomes.…”

Section: Introductionmentioning

confidence: 99%

“…The contribution of the paper is twofold. First, we consider the case where the monetary authority is only faced with uncertainty on the side of the parameters of the data generating process 1 due to, for instance, insufficient estimation techniques, rather than the entire transmission mechanism itself as analyzed in Ilbas et al (2012). Hence, we consider certainty with respect to the structure of the economy but parameters are assumed to be unknown and remain constant over time which clearly influences the effectiveness of policy actions.…”

Section: Introductionmentioning

confidence: 99%

See 4 more Smart Citations

Optimal policy and Taylor rule cross-checking under parameter uncertainty

Bursian

Roth

2014

The B.E. Journal of Macroeconomics

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We examine whether the robustifying nature of Taylor rule cross-checking under model uncertainty carries over to the case of parameter uncertainty. Adjusting monetary policy based on this kind of cross-checking can improve the outcome for the monetary authority. This, however, crucially depends on the relative welfare weight that is attached to the output gap and also the degree of monetary policy commitment. We find that Taylor rule cross-checking is on average able to improve losses when the monetary authority only moderately cares about output stabilization and when policy is set in a discretionary way.

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Section: The Conduct Of Monetary Policymentioning

confidence: 99%

Section: The Conduct Of Monetary Policymentioning

confidence: 99%

Section: The Conduct Of Monetary Policymentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

See 3 more Smart Citations

Optimal policy and Taylor rule cross-checking under parameter uncertainty

Bursian

Roth

2014

The B.E. Journal of Macroeconomics

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Lessons from the Past and Directions for the Future

2012

New Drctns for Instit Rsrch

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Cross-checking optimal monetary policy with information from the Taylor rule

Tillmann

2012

Economics Letters

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Recently, Røisland and Sveen (2010) study these two motives. They specify a central bank's loss function that is a weighted average between a standard part that increases in inflation and output variances and a non-standard part that penalizes squared deviations of the interest rate from its level prescribed by the Taylor rule. They simulate a series of economic models under this particular loss function under the assumption that monetary policy is able to commit to the optimal policy path. Their results show a clear trade-off between robustness and optimality. Putting some weight on deviations from the robust rule leads to a welfare loss but avoids high losses if an alternative model is the true description of the economy. Terms of use: Documents in EconStor mayIn this paper we show that if the central bank cannot commit to the first-best policy and instead formulates policy under discretion, the trade-off can break down. Delegating monetary policy to a central bank that attaches some weight on deviations from the Taylor rule can actually improve welfare in terms of inflation and output volatility. Put differently, policy should be delegated to a central banker that cross-checks optimal interest rate setting with information from a simple Taylor rule.The reason for this finding is that placing a weight on deviations from a Taylor rule increases the effective weight of inflation volatility in the loss function, which reduces the stabilization bias of discretionary monetary policy. 2 Since the public knows that inflation will respond less to a cost-push shock, expected future inflation is subdued. 2 The model The economic structureConsider the simplest version of a New-Keynesian model, which represents a set of loglinearized equilibrium conditions derived from a standard sticky-price general equilibrium model. Inflation is described by a forward-looking Phillips curve (1). Here   is the inflation rate,   the output gap, and E  is the expectations operator. The discount factor is denoted by 1 and ,t h es l o p ec o e fficient of the Phillips curve, is inversely related to the degree of nominal rigidities 4The IS curve (2) describes the demand side of the economywhere   is the risk-free interest rate controlled by the central bank and the coefficient  is the inverse of the intertemporal elasticity of substitution. The cost-push shock   introduces a stabilization motive for monetary policy and exhibits some degree of persistence described by th...

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Robustifying Optimal Monetary Policy Using Simple Rules as Cross-Checks

Cited by 25 publications

References 25 publications

Optimal policy and Taylor rule cross-checking under parameter uncertainty

Optimal policy and Taylor rule cross-checking under parameter uncertainty

Lessons from the Past and Directions for the Future

Cross-checking optimal monetary policy with information from the Taylor rule

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