U.S. Macroeconomic Policy Evaluation in an Open Economy Context using Wavelet Decomposed Optimal Control Methods

Patrick Crowley and David Hudgins

No 11/2019, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: It is widely recognized that the policy objectives of fiscal and monetary policymakers usually have different time horizons, and this feature may not be captured by traditional econometric techniques. In this paper, we first decompose U.S macroeconomic data using a time-frequency domain technique, namely discrete wavelet analysis. We then model the behavior of the U.S. economy over each wavelet frequency range and use our estimated parameters to construct a tracking model. To illustrate the usefulness of this approach, we simulate jointly optimal fiscal and monetary policy with different short-term targets: an inflation target, a money growth target, an interest rate target, and a real exchange rate target. The results determine the reaction in fiscal and monetary policy that is required to achieve an inflation target in a low inflation environment, and when both fiscal and monetary policy are concerned with meeting certain economic growth objectives. The combination of wavelet decomposition in an optimal control framework can also provide a new approach to macroeconomic forecasting.

JEL-codes: C61 C63 C88 E52 E61 F47 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (2)

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