Two papers on monetary policy

Monetary
policy in an uncertain world: Probability models and the design of
robust monetary rules by Paul Levine.

The abstract reads: The past forty years or so has seen a
remarkable transformation in macro-models used by central banks,
policymakers and forecasting bodies. This paper describes this
transformation from reduced-form behavioural equations estimated
separately, through contemporary micro-founded dynamic stochastic
general equilibrium (DSGE) models estimated by systems methods. In
particular by treating DSGE models estimated by
Bayesian-Maximum-Likelihood methods I argue that they can be
considered as probability models in the sense described by Sims
(2007) and be used for risk-assessment and policy design. This is
true for any one model, but with a range of models on offer it is
also possible to design interest rate rules that are simple and
robust across the rival models and across the distribution of
parameter estimates for each of these rivals as in Levine et
al. (2008). After making models better in a number of important
dimensions, a possible road ahead is to consider rival models as
being distinguished by the model of expectations. This would avoid
becoming `a prisoner of a single system' at least with respect to
expectations formation where, as I argue, there is relatively less
consensus on the appropriate modelling strategy.

A
Floating versus Managed Exchange Rate Regime in a DSGE Model of
India by Nicoletta Batini, Vasco Gabriel, Paul Levine
and Joseph Pearlman.

The abstract reads: We first develop a two-bloc model of an
emerging open economy interacting with the rest of the world
calibrated using Indian and US data. The model features a
financial accelerator and is suitable for examining the effects
of financial stress on the real economy. Three variants of the
model are highlighted with increasing degrees of financial
frictions. The model is used to compare two monetary interest
rate regimes: domestic Inflation targeting with a floating
exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both
rules are characterized as a Taylor-type interest rate rules. MEX
involves a nominal exchange rate target in the rule and a
constraint on its volatility. We find that the imposition of a
low exchange rate volatility is only achieved at a significant
welfare loss if the policymaker is restricted to a simple
domestic inflation plus exchange rate targeting rule. If on the
other hand the policymaker can implement a complex optimal rule
then an almost fixed exchange rate can be achieved at a
relatively small welfare cost. This finding suggests that future
research should examine alternative simple rules that mimic the
fully optimal rule more closely.

You might like to
see: the
stock of papers from the NIPFP Macro/Finance Group.