Monetary Policy Rules: Model Uncertainty Meets Design Limits

Abstract

We offer a contribution to the analysis of optimal monetary policy. The canonical approach to determine what policy rule a central bank should follow is to take a single structural model and minimize the unconditional volatilities of inflation and real activity. In this paper, we design monetary policy rules that robustly perform well across a wide set of structural models and that minimize the volatilities at those frequencies policymakers are most interested in stabilizing. We find that rules robust to model uncertainty call for much less aggressive responses by policymakers. Frequency-specific stabilization preferences further dampen their optimal policy responses.

Keywords: monetary policy rules, policy evaluation, model comparison, model uncertainty, frequency domain, design limits, DSGE models

JEL Classification: C49, E32, E37, E52, E58