Optimal simple monetary policy rules and welfare in a DSGE Model for Hungary

Abstract

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.monetary policy, central banking, policy design