Optimal Policy Projections

28 Pages Posted: 6 Jul 2005 Last revised: 19 Aug 2022

See all articles by Lars E. O. Svensson

Lars E. O. Svensson

Stockholm School of Economics; Stockholm University - Institute for International Economic Studies (IIES); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Robert J. Tetlow

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: June 2005

Abstract

We outline a method to provide advice on optimal monetary policy while taking policymakers' judgment into account. The method constructs Optimal Policy Projections (OPPs) by extracting the judgment terms that allow a model, such as the Federal Reserve Board's FRB/US model, to reproduce a forecast, such as the Greenbook forecast. Given an intertemporal loss function that represents monetary policy objectives, OPPs are the projections - of target variables, instruments, and other variables of interest -that minimize that loss function for given judgment terms. The method is illustrated by revisiting the Greenbook forecasts of February 1997 and November 1999, in each case using the vintage of the FRB/US model that was in place at that time. These two particular forecasts were chosen, in part, because they were at the beginning and the peak, respectively, of the late 1990s boom period. As such, they differ markedly in their implied judgments of the state of the world, and our OPPs illustrate this difference. For a conventional loss function, our OPPs provide significantly better performance than Taylor-rule simulations.

Suggested Citation

Svensson, Lars E.O. and Tetlow, Robert J., Optimal Policy Projections (June 2005). NBER Working Paper No. w11392, Available at SSRN: https://ssrn.com/abstract=734048

Lars E.O. Svensson (Contact Author)

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Centre for Economic Policy Research (CEPR)

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Robert J. Tetlow

Board of Governors of the Federal Reserve System ( email )

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