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Optimal monetary policy using an unrestricted VAR
Author(s) -
Polito Vito,
Wickens Mike
Publication year - 2010
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.1219
Subject(s) - vector autoregression , monetary policy , economics , constraint (computer aided design) , benchmark (surveying) , econometrics , inflation (cosmology) , taylor rule , simple (philosophy) , interest rate , welfare , nominal interest rate , mathematical economics , macroeconomics , mathematics , real interest rate , central bank , philosophy , physics , geometry , geodesy , epistemology , theoretical physics , geography , market economy
SUMMARY This paper proposes a simple benchmark for monetary policy. Assuming the true model of the economy is unknown, it is based on an unrestricted vector autoregression (VAR). The key result is that instead of deriving optimal policy using the original VAR equations as the constraint, when no restriction is placed on the correlation structure of the VAR disturbances, the constraint should be formed from a transformation of the VAR. This method is applied to the USA, 1964–2009. Significant welfare gains are found compared with actual policy and using a Taylor rule. Incorporating a zero interest rate lower bound lowers output and inflation. Copyright © 2010 John Wiley & Sons, Ltd.