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Optimal policy perturbations

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Abstract

Model mis-specification remains a major concern in macroeconomics, and policy makers must often resort to heuristics to decide on policy actions; combining insights from multiple models and relying on judgment calls. Identifying the most appropriate, or optimal, policy in this manner can be challenging however. In this work, we propose a statistic -the Optimal Policy Perturbation (OPP)- to detect "optimization failures" in the policy decision process. The OPP does not rely on any specific underlying economic model, and its computation only requires (i) forecasts for the policy objectives conditional on the policy choice, and (ii) the impulse responses of the policy objectives to shocks to the policy instruments. We illustrate the OPP in the context of US monetary policy decisions. In forty years, we only detect one period with major optimization failures; during 2010-2012 when unconventional policy tools should have been used more intensively.

Suggested Citation

  • Régis Barnichon & Geert Mesters, 2020. "Optimal policy perturbations," Economics Working Papers 1716, Department of Economics and Business, Universitat Pompeu Fabra.
    • Handle: RePEc:upf:upfgen:1716
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    More about this item

    Keywords

    macroeconomic stabilization; optimal policy; impulse responses; sufficient statistics; forecast targeting;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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