Monetary Policy Design under Competing Models of Inflation Persistence

Solange Gouvea, Banco Central Do Brasil
Abhijit Sen Gupta, Indian Council for Research on International Economic Relations

Abstract

Most of the recent research in monetary policy has focused on the use of a single exogenously specified standard ad hoc loss function to evaluate policy performance. This literature has come to the conclusion that backward looking models are more difficult to control. In this paper we test the validity of this conclusion using both a standard ad hoc loss function and a model consistent loss function. We find that conclusions vary markedly with different types of loss functions. We also look into the case where the policymaker is uncertain about the pricing behavior of firms and investigate the presence of robust policy rules. We find that the existence of robust rules depend crucially on the type of loss function used to evaluate outcomes.