url
26
Jul
2014

SIMPLE MONETARY POLICY RULES UNDER MODEL UNCERTAINTY: Robustness to Model Uncertainty 3

In particular, we take two complicated rules (denoted by T”and “Q”) from the 12-parameter E-frontier of the MSR model, and determine the performance of these rules in the FRB model and in TAYMCM. Because rules P and Q cannot be implemented directly in the FM model (which does not explicitly treat the components of aggregate demand), we also take two rules (denoted by “R” and “S”) from the 8-parameter E-frontier of the MSR model and evaluate the performance of these rules in the FM model.

As above, the output and inflation variability of the complicated rules should be compared with simple rules that generate the same level of interest rate volatility. Thus, for each model, we calculate the funds rate volatility associated with each of the two complicated rules, and then we compute a separate policy frontier for each upper bound on funds rate volatility, using the class of 3-parameter rules given by equation (4).


w6570-23
w6570-24

As shown in the left panels of Figure 10, the more complicated rules lie fairly close to the 3-parameter policy frontiers of the FM and FRB models. In TAYMCM, however, the two 12-parameter rules are much less effective in stabilizing output and inflation than the optimal 3-parameter rules. Thus, while small improvements in output and inflation variability may be obtained by using complicated policy rules, these rules are somewhat less robust to model uncertainty compared with simple rules. As discussed in Section 2, the dynamic properties of output and inflation differ substantially across the four models. Thus, it is not very surprising that fine-tuning a complicated rule to one particular model may not be appropriate when policymakers are concerned about model uncertainty.

In particular, we take two complicated rules (denoted by T”and “Q”) from the 12-parameter E-frontier of the MSR model, and determine the performance of these rules in the FRB model and in TAYMCM. Because rules P and Q cannot be implemented directly in the FM model (which does not explicitly treat the components of aggregate demand), we also take two rules (denoted by “R” and “S”) from the 8-parameter E-frontier of the MSR model and evaluate the performance of these rules in the FM model. As above, the output and inflation variability of the complicated rules should be compared with simple rules that generate the same level of interest rate volatility. Thus, for each model, we calculate the funds rate

About The Author

Kevin J. Brandon

Home | Site Map | Contacts

Copyright © 2013 - 2019 Investment And Finance Online. All rights reserved