Board of Governors of the Federal Reserve System

July 2011

Optimal Monetary Policy in an Operational Medium-Sized DSGE Model

Malin Adolfson, Stefan Laséen, Jesper Lindé, and Lars E.O. Svensson

Abstract:

We show how to construct optimal policy projections in Ramses, the Riksbank's open-economy medium-sized DSGE model for forecasting and policy analysis. Bayesian estimation of the parameters of the model indicates that they are relatively invariant to alternative policy assumptions and supports our view that the model parameters may be regarded as unaffected by the monetary policy specification. We discuss how monetary policy, and in particular the choice of output gap measure, affects the transmission of shocks. Finally, we use the model to assess the recent Great Recession in the world economy and how its impact on the economic development in Sweden depends on the conduct of monetary policy. This provides an illustration on how Rames incoporates large international spillover effects.

Keywords: Optimal monetary policy, instrument rules, optimal policy projections, open-economy DSGE models

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