Welfare Implications of Alternative Monetary Policy Rules: A New Keynesian DSGE Model for Turkey

Abstract

Abstract:In recent years, there has been extensive research on the conduct of monetary policy in small open economies that are subject to inflation and output fluctuations. Policymakers should decide whether to implement strict inflation targeting or to respond to the changes in output fluctuations while conducting monetary policy rule. This study aims to examine the response of alternative monetary policy rules to Turkish economy by means of a DSGE model that is subject to demand and technology shocks. The New Keynesian model we used is borrowed from Gali (2015) and calibrated for the Turkish economy. Welfare effects of alternative Taylor rules are evaluated under different specifications of central bank loss function. One of the main findings of this paper is that in the case of a technology shock, strict inflation targeting rules provide the minimum welfare loss under all loss function configurations. On the contrary, the losses are weakened if the monetary authority responds to output fluctuations in the presence of a demand shock. Finally, there exists a trade-off between the volatility of output and inflation in case of a technology shock, while the volatility of both variables moves in the same direction in response to a demand shock.

State-level Taylor rule and monetary policy stress

“…The three TR specifications that frame our empirical strategy are as follows (Gajewski, 2016;Rusnák et al, 2013;Caputo & Diaz, 2018;Gerlach & Schnabel, 2000;Taylor, 1999;Woodford, 2000;Yağcıbaşı & Yıldırım, 2019, Avdijev & Hale, 2019Bernanke et al, 2019):…”

“…Over the last few decades, the Taylor Rule (TR) framework has been the most influential toolbox to design policy prescriptions for central banks around an inflation-targeting world (Gerlach & Schnabel, 2000;Taylor, 1999;Woodford, 2000;Yağcıbaşı & Yıldırım, 2019;Avdijev & Hale, 2019;Bernanke et al, 2019). Its main advantage is often argued to lie with providing macroeconomic stabilization by reducing uncertainty about future monetary policy actions (Gerlach & Schnabel, 2000), while also improving communication between central banks and the general public (Orphanides, 2007).…”

Measuring monetary policy by money supply and interest rate: evidence from emerging economies

“…Others, however, using interest rate as an overall measure of monetary policy in the analysis of the Taylor rule. See, for instance, Furlani, Portugal and Laurini (2010), De Mello and Moccero (2011), Sánchez-Fung (2011), Cermeño, Villagómez and Polo (2012, Jawadi, Mallick and Sousa (2014), and Yağcıbaşı and Yıldırım (2017), to name a few. However, the practical institutions raise doubts about the prior that interest rate is the best measure of monetary policy in emerging economies.…”

Inflationary effects of fiscal and monetary policies in Indonesia

“…However, these studies do not include shock variables that probably emerge in the economy. Furthermore, we use a single period welfare loss function at period t   t WLF which involves shock variables to construct the estimable dynamic model as also used in previous research (Domowitz & Elbadawi, 1987;Gupta & Uwilingiye, 2008;Insukindro & Sahadewo, 2010;Yağcıbaşı & Yıldırım, 2017). The proposed model begins with some reasons of using single period welfare loss function and then followed by the construction of estimable error correction model.…”