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1
Aug
2014

SIMPLE MONETARY POLICY RULES UNDER MODEL UNCERTAINTY: Appendix

Our initial results indicate that within a fairly wide range of alternative foreign monetary policy assumptions (e.g., fixed money growth, interest rate rules), the specific foreign monetary policy regime appear to have only minor implications for the properties of a U.S. monetary policy rule. For example, consider the class of rules in which the first-difference of the federal funds rate responds to the current output gap and inflation deviation from target.

Table 7 provides information about the U.S. inflation-output volatility frontier under two alternative assumptions about foreign monetary policy: (a) each foreign G-7 country follows a fixed money growth rule; or (b) France, Germany, Italy, and the U.K. belong to a monetary union in which the European Central Bank adjusts interest rates in response to the European average output gap and average inflation deviation from target, while Canada and Japan independently follow similar rules. Table 7 shows that in TAYMCM, neither the position of the U.S. inflation-output volatility frontier nor the coefficients of rules on the policy frontier are sensitive to this choice of foreign monetary policy assumptions. Impulse response functions generated using the full FRB staff model (cf. Levin et al. 1997) yield similar conclusions.

Based on these results, the results in this paper are based on a smaller version of the FRB staff model, referred to as the FRB model. In this model, foreign output, prices, ex ante long-term real interest rates, and the oil import price deflator are generated by simple autoregressive processes. The trade-weighted real exchange rate is determined by the differential between U.S. and foreign ex ante long-term real interest rates, with an endogenous risk premium that ensures a stable ratio of net external debt to nominal GDP.

Our initial results indicate that within a fairly wide range of alternative foreign monetary policy assumptions (e.g., fixed money growth, interest rate rules), the specific foreign monetary policy regime appear to have only minor implications for the properties of a U.S. monetary policy rule. For example, consider the class of rules in which the first-difference of the federal funds rate responds to the current output gap and inflation deviation from target. Table 7 provides information about the U.S. inflation-output volatility frontier under two alternative assumptions about foreign monetary policy: (a) each foreign G-7 country follows a fixed money growth rule; or (b) France, Germany, Italy, and the U.K. belong to a monetary union in which the European Central Bank adjusts

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Kevin J. Brandon

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