Abstract: What is a good monetary policy rule for stabilizing the economy? In
this paper, efficient policy rules are computed using the FRB/US
large-scale open-economy macroeconometric model. Simple
three-parameter policy rules are found to be very effective at
minimizing fluctuations in inflation, output, and interest rates:
Increases in rule complexity yield only trivial reductions in
aggregate variability. Under rational expectations, efficient policies
smooth the interest rate response to shocks and use the feedback from
anticipated policy actions to stabilize inflation and output and to
moderate movements in short-term interest rates. Policy should react
to a multi-period inflation rate rather than the current quarter
inflation rate; in fact, targeting the price level, as opposed to the
inflation rate, involves only small additional stabilization costs. These
results are robust to parameter and model uncertainty and the
imposition of the non-negativity constraint on nominal interest rates.
However, if expectations formation is invariant to policy, as in
backward-looking models, the expectations channel is shut off and the
performance of policies that are efficient under rational expectations
may, as a result, deteriorate markedly; efficient policies, in contrast,
exploit systematic expectational errors.
Keywords: Monetary policy rules, macroeconometric models, rational expectations
Full paper (280 KB PDF)
| Full paper (711 KB Postscript)
Home | Economic research and data | FR working papers | FEDS | 1999 FEDS papers
Accessibility
To comment on this site, please fill out our feedback form.
Last update: March 25, 1999
|