Robustifying Optimal Monetary Policy in Norway

Abstract

Monetary policy is usually modelled as either simple rules or optimal policy. While the former are often seen as incomplete and unrealistic for practical policymaking, the latter can yield catastrophy should the policymaker's macroeconomic model be wrong. I seek to "robustify" the optimal policy from Norges Bank's reference model, NEMO, when there are alternative possible models with very different structural properties. This is done by punishing deviations from a simple interest rate rule in a "modified" welfare loss function. I consider several simple rules for this purpose, among them the simple Taylor rule and several rules that are optimized for the alternative models. The combination of optimal policy and simple rules turn out to be effective for avoiding large welfare losses in the alternative models and creating an acceptable trade-off. In addition, the method is flexible and can easily be implemented by central banks.