Beyond one-size-fits-all: Designing monetary policy for diverse models and frequencies

Alexander Dück and Fabio Verona

No 2/2025, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We offer a contribution to the analysis of optimal monetary policy. The standard approach to determine what policy rule a central bank should follow is to take a single structural model and minimize the unconditional volatilities of inflation and real activity. In this paper, we propose monetary policy rules that perform robustly across a broad range of structural models, focusing on minimizing volatility at the frequencies most relevant for policymakers' stabilization goals. Our findings indicate that robust rules, which account for model uncertainty, advocate significantly less aggressive policy responses. Moreover, incorporating frequency-specific stabilization preferences further moderates the optimal policy actions. Ignoring model uncertainty imposes significant costs, while the cost of insuring against this uncertainty is relatively low. This cost-benefit analysis strongly supports adopting a robust-model approach to monetary policy.

Keywords: monetary policy rules; policy evaluation; model comparison; model uncertainty; frequency domain; design limits; DSGE models (search for similar items in EconPapers)
JEL-codes: C49 E32 E37 E52 E58 (search for similar items in EconPapers)
Date: 2025
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:308813

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