Complexity and Monetary Policy
by Athanasios Orphanidesa and Volker Wielandb
The complexity resulting from intertwined uncertainties
regarding model misspecification and mismeasurement of the
state of the economy defines the monetary policy landscape.
Using the euro area as a laboratory, this paper explores the
design of robust policy guides aiming to maintain stability in
the economy while recognizing this complexity. We document
substantial output-gap mismeasurement and make use of a new
model database to capture the evolution of model specification.
A simple interest rate rule is employed to interpret ECB policy
since 1999. An evaluation of alternative policy rules across
eleven models of the euro area confirms the fragility of policy
analysis optimized for any specific model and shows the merits
of model averaging in policy design. Interestingly, a simple difference
rule with the same coefficients on inflation and output
growth as the one used to interpret ECB policy is quite robust
as long as it responds to current outcomes of these variables.
JEL Codes: E50, E52, E58.
(PDF, 37 pages 716 kb)
Discussion by Lars E.O. Svensson
Discussion by Glenn D. Rudebusch
a Massachusetts Institute of Technology
b University of Frankfurt