Optimal Policy with Occasionally Binding Constraints: Piecewise Linear Solution Methods

90 Pages Posted: 2 Mar 2021

See all articles by Richard Harrison

Richard Harrison

Bank of England - Monetary Analysis

Matthew Waldron

Bank of England

Date Written: February 26, 2021

Abstract

This paper develops a piecewise linear toolkit for optimal policy analysis of linear rational expectations models, subject to occasionally binding constraints on (multiple) policy instruments and other variables. Optimal policy minimises a quadratic loss function under either commitment or discretion. The toolkit accounts for the presence of ‘anticipated disturbances’ to the model equations, allowing optimal policy analysis around scenarios or forecasts that are not produced using the model itself (for example, judgement-based forecasts such as those often produced by central banks). The flexibility and applicability of the toolkit to very large models is demonstrated in a variety of applications, including optimal policy experiments using a version of the Federal Reserve Board’s FRB/US model.

Keywords: Optimal policy, commitment, discretion, occasionally binding constraints

JEL Classification: C61, C63, E61

Suggested Citation

Harrison, Richard and Waldron, Matthew, Optimal Policy with Occasionally Binding Constraints: Piecewise Linear Solution Methods (February 26, 2021). Bank of England Working Paper No. 911, Available at SSRN: https://ssrn.com/abstract=3796319 or http://dx.doi.org/10.2139/ssrn.3796319

Richard Harrison (Contact Author)

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Matthew Waldron

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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