Evaluating interest rate rules in an estimated DSGE model

Abstract: The empirical DSGE (dynamic stochastic general equilibrium) literature pays surprisingly little attention to the behavior of the monetary authority. Alternative policy rule specifications abound, but their relative merit is rarely discussed. We contribute to filling this gap by comparing the fit of a large set of interest rate rules (fifty-five in total), which we estimate within a simple New Keynesian model. We find that specifications in which monetary policy responds to inflation and to deviations of output from its efficient level?the one that would prevail in the absence of distortions?have the worst fit within the set we consider. Policies that respond to measures of the output gap based on statistical filters perform better, but the best-fitting rules are those that also track the evolution of the model-consistent efficient real interest rate.

Keywords: Stochastic analysis; Monetary policy; Keynesian economics; Interest rates; Gross domestic product;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2011

Number: 510