Robustness and evaluation of monetary policy

The thread running through the project is the analysis of the determination of the short interest rate in the interbank market by the central bank. It is both associated with how the central bank ought to set interest rates to maximize economic welfare an d how they empirically set interest rates. The determination of the short-term interest rate has repercussions for all financial markets, including the foreign exchange market, the bond and the stock markets. Therefore the insight provided by the projects is likely to have implications for understanding not only monetary policy, but also other aspects of the financial markets. The first part of the project (with Ulf Söderström, Bocconi University, and Richard Dennis, Federal Reserve Bank of San Francisco ) is the most straightforward extension of the former project supported by the Financial Market Fund. We plan to establish numerical routines of the robust control technique we suggested in the former project. We plan to use these routines in order to qua ntify the effects of model uncertainty in economies with different forms of persistence, both in the inflation and output equations. We also want to consider simpler models in which analytical solutions are available. We want to host an annual research co nference on monetary policymaking under model uncertainty in 2006. A second research conference is planned for 2007 and will consider the use of financial market information for the conduct of monetary policy. The second part of the project will consider the evaluation of monetary policy. We use VAR model techniques in identifying both the systematic part of monetary policy, as well as shocks to inflation target (permanent shocks) and transitory monetary policy shocks to the interest rate. Identification allows comparison of empirical policymaking with the optimality conditions of monetary policy. We will also evaluate policies through the direct estimation of the optimality conditions and check its fitness.