Robustifying Optimal Monetary Policy Using Simple Rules as Cross-Checks

30 Pages Posted: 25 May 2013

See all articles by Pelin Ilbas

Pelin Ilbas

National Bank of Belgium - Research Department

Øistein Røisland

Norges Bank - Department of Economics

Tommy Sveen

Norges Bank - Research Department

Date Written: December 17, 2012

Abstract

There are two main approaches to modelling monetary policy; simple instrument rules and optimal policy. We propose an alternative that combines the two by extending the loss function with a term penalizing deviations from a simple rule. We analyze the properties of the modified loss function by considering three different models for the US economy. The choice of the weight on the simple rule determines the trade-off between optimality and robustness. We show that by placing some weight on a simple Taylor-type rule in the loss function, one can prevent disastrous outcomes if the model is not a correct representation of the underlying economy.

Keywords: Model uncertainty, Optimal control, Simple rules

JEL Classification: E52, E58

Suggested Citation

Ilbas, Pelin and Røisland, Øistein and Sveen, Tommy, Robustifying Optimal Monetary Policy Using Simple Rules as Cross-Checks (December 17, 2012). Norges Bank Working Paper 2012-22. Available at SSRN: https://ssrn.com/abstract=2269236 or http://dx.doi.org/10.2139/ssrn.2269236

Pelin Ilbas

National Bank of Belgium - Research Department ( email )

Research Department
Boulevard de Berlaimont 14
B-1000 Brussels, 1000
Belgium

Øistein Røisland (Contact Author)

Norges Bank - Department of Economics ( email )

P.O. Box 1179
Oslo, N-0107
Norway
+47 22 31 67 39 (Phone)
+47 22 31 60 50 (Fax)

Tommy Sveen

Norges Bank - Research Department ( email )

P.O. Box 1179
Oslo, N-0107
Norway

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