Recursive Thick Modeling and the Choice of Monetary Policy in Mexico
38 Pages Posted: 2 Oct 2006
Date Written: October 2006
The choice of monetary policy is the most important concern of central banks, but this choice is always confronted with two relevant aspects of economic policy: parameter instability and model uncertainty. This paper deals with both types of uncertainty and shows that recursive thick modeling is a better approximation to the recent historical nominal interest rates in Mexico than both recursive thin modeling and models with a low penalty on interest rate variability. We complement previous work by evaluating the usefulness of both recursive thick modeling and recursive thin modeling in terms of direction-of-change forecastability. The results show a policy maker who cares about inflation and output stabilization the same for downward movements in nominal interest rates. Furthermore, our results suggest a policy maker with a higher preference for inflation stabilization for upward movements in nominal interest rates.
Keywords: macroeconomic policy, model uncertainty, optimal control, monetary policy
JEL Classification: C61, E61
Suggested Citation: Suggested Citation