The Optimality of the US and Euro Area Taylor Rule

Ferhat Mihoubi and Pascal Jacquinot

No 220, Computing in Economics and Finance 2004 from Society for Computational Economics

Abstract: The purpose of this paper is to examine the optimality of the monetary authorities reaction function in the two-area medium size model MARCOS (US and euro areas). The parameters and the horizons of output gap and inflation expectations of the Taylor rule are computed in order to minimise a loss function of the monetary authorities. However, investigating the optimality of the Taylor rule in the context of a large scale macroeconomic model raises several difficulties: the model is non-linear and all the state variables potentially enter the optimal monetary policy rule. Furthermore, the optimality of the Taylor rule is assessed by the minimisation of the loss function under the constraint of a large forward-looking model. To overcome these problems, Black, Macklem and Rose [1998] propose a stochastic simulation based method which has been applied to single-country macroeconomic models. To study the optimality of the Taylor rule in the case of a two-area model, we suppose that the economy is stochastically hit by numerous shocks (supply, demand, monetary, exchange rate and world demand) in each area and simulate MARCOS stochastically.

Keywords: Monetary Policy; Computational Techniques; International Policy Transmission (search for similar items in EconPapers)
JEL-codes: C63 E52 E63 F42 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-cba, nep-eec, nep-ifn and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:sce:scecf4:220

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