How the choice of AS curve affects the optimal monetary policy rule: The case of Japan

Bei Liu, Fordham University

Abstract

This paper uses the trade-off approach for the model uncertainty to evaluate the efficiency of monetary policy when the risk-neutral central bank sets the optimal policy rule without noticing the accuracy of the chosen New Keynesian model in Japan. Results show estimated Calvo optimal policy rules are more aggressive than estimated P-bar optimal policy rules in any style of inflation targeting. When there is no model risk problem Calvo New Keynesian model (CNKM) better performs than the worst-case model of the P-bar New Keynesian model (PNKM) depending on the style of inflation targeting; while when model uncertainty happens, losses by both models are increasing, and they become quadratic as the weight on inflation in the loss function decreasing. Extra losses in CNKM are larger than them in PNKM in any style of inflation targeting. Furthermore when the central bank only concerns one economic indicator (either inflation or the output gap) as the only target, it faces more risks of model uncertainty by using CNKM for monetary policy analysis.^

Subject Area

Economics, General

Recommended Citation

Liu, Bei, "How the choice of AS curve affects the optimal monetary policy rule: The case of Japan" (2013). ETD Collection for Fordham University. AAI3588220.
https://fordham.bepress.com/dissertations/AAI3588220

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