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WP 2010/4. Zoltán M. Jakab–Henrik Kucsera–Katalin Szilágyi–Balázs Világi: Optimal simple monetary policy rules and welfare in a DSGE Model for Hungary

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We explore the properties of welfare-maximizing monetary policy in a medium-scale DSGE model for Hungary. In order to make our results operational from a policymaker’s perspective, we approximate the optimal policy rule with a set of simple rules reacting only to observable variables. Our results suggest that “science of monetary policy” that is found robust in simple models, holds in this medium-scaled setting as well. That is, the welfare-maximizing policy that aims to eliminate distortions associated with nominal rigidities can be approximated by a simple inflation targeting rule. Adding exchange rate into the feedback rule only marginally improves the stabilization properties of the policy rule. However, a rule reacting to wage inflation can be significantly welfare-improving. These results may suggest that in our medium-sized model the distortions associated with sticky wage setting have at least as important welfare implications as those related to the price stickiness in product markets.
JEL: E52, E58, E61.
Keywords: monetary policy, central banking, policy design.

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