Simple Monetary Policy Rules Under Model Uncertainty
IMF Working Papers, May 1, 1999
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Bibliographic details
- Authors: Ann-Charlotte Eliasson, Peter Isard, Douglas Laxton
- Published: May 1, 1999
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451849714.001
Summary and central finding
- Using stochastic simulations and stability analysis, the paper compares how different monetary rules perform in a moderately nonlinear model with a time-varying nonaccelerating-inflation-rate-of-unemployment (NAIRU).
- Rules that perform well in linear models but implicitly embody backward-looking measures of real interest rates (such as conventional Taylor rules) or substantial interest rate smoothing perform very poorly in models with moderate nonlinearities, particularly when policymakers tend to make serially correlated errors in estimating the NAIRU.
- This challenges the practice of evaluating rules within linear models, in which the consequences of responding myopically to significant overheating are extremely unrealistic.
Methodology
- Stochastic simulations.
- Stability analysis.
- Evaluation conducted in a moderately nonlinear macroeconomic model with a time-varying NAIRU.
Key results and implications
- Conventional Taylor rules and rules with substantial interest rate smoothing can perform well in linear models but fail in the presence of moderate nonlinearities.
- Backward-looking measures of real interest rates embedded in some policy rules amplify poor outcomes when estimates of the NAIRU contain serially correlated errors.
- Linear-model-based evaluations understate the adverse consequences of myopic policy responses to significant overheating.
Policy recommendations and considerations
- Policymakers should be cautious in relying on policy-rule evaluations conducted solely within linear models.
- Monetary policy frameworks should account for model nonlinearities and uncertainty about the NAIRU, especially the possibility of serially correlated estimation errors.
- Rules that rely less on backward-looking real-rate measures and avoid excessive interest rate smoothing may be more robust in nonlinear environments.
IMF Working Paper "Simple Monetary Policy Rules Under Model Uncertainty" by Ann-Charlotte Eliasson, Peter Isard, and Douglas Laxton.
Content in this bundle
- Simple Monetary Policy Rules Under Model Uncertainty - WP/99/75