Abstract: In this paper, we investigate the properties of alternative
monetary policy rules using four structural macroeconometric models:
the FuhrerMoore model, Taylor's MultiCountry Model, the MSR model of
Orphanides and Wieland, and the FRB staff model. All four models
incorporate the assumptions of rational expectations, shortrun nominal
inertia, and longrun monetary neutrality, but differ in many other
respects (e.g., the dynamics of prices and real expenditures). We
compute the outputinflation volatility frontier of each model for
alternative specifications of the interest rate rule, subject to an
upper bound on nominal interest rate volatility. Our analysis provides
strong support for rules in which the firstdifference of the federal
funds rate responds to the current output gap and the deviation of the
oneyear average inflation rate from a specified target. In all four
models, firstdifference rules perform much better than rules of the
type proposed by Taylor (1993) and Henderson and McKibbin (1993), in
which the level of the federal funds rate responds to the output gap
and the deviation from target. Furthermore, firstdifference rules
generate essentially the same policy frontier as more complicated
rules (i.e., rules that respond to a larger number of variables and/or
additional lags of output and inflation). Finally, this class of rules
is robust to model uncertainty, in the sense that a firstdifference
rule taken from the policy frontier of one model is very close to the
policy frontier of each of the other three models. In contrast, more
complicated rules are less robust to model uncertainty: rules with
additional parameters can be finetuned to the dynamics of a specified
model, but typically perform poorly in the other models.
Keywords: Monetary policy, policy rules, model uncertainty, rational expectation models
Full paper (197 KB PDF)
 Full paper (464 KB Postscript)
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