2001): “The performance of forecast-based monetary policy rules under model uncertainty”, ECB Working Paper, no 68

We investigate the performance of forecast-based monetary policy rules using five macroeconomic models that reflect a wide range of views on aggregate dynamics. We identify the key characteristics of rules that are robust to model uncertainty; such rules respond to the one-year-ahead inflation forecast and to the current output gap and incorporate a substantial degree of policy inertia. In contrast, rules with longer forecast horizons are less robust and are prone to generating indeterminacy. Finally, we identify a robust benchmark rule that performs very well in all five models over a wide range of policy preferences. (JEL E31, E52, E58, E61) A number of industrialized countries have adopted explicit inflation forecast targeting re-gimes, in which the stance of policy is adjusted to ensure that the inflation rate is projected to return to target over a specified horizon.1 Such a regime has also received formal consideration recently by the Bank of Japan, while Svensson (1999) and others have recommended that the Federal Reserve and the European Central Bank should follow suit.2 In principle, forecast-based policies can incorporate comprehensive and up-to-date macroeconomic information and can ac-count for transmission lags and other structural features of the economy. Furthermore, simple forecast-based policy rules may serve as useful benchmarks that facilitate public communica-tion regarding monetary policy objectives and procedures.3 In analyzing forecast-based policies, re-searchers have generally proceeded by deter-mining rules that yield optimal or near-optimal stabilization performance in a specific macro-econometric model.4 However, given substan