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Working Paper Summaries (WP/92/1 - WP/92/47)
Article

“Specification of Policy Rules and Performance Measures in Multicountry Simulation Studies”

Author(s):
International Monetary Fund
Published Date:
August 1992
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Many recent studies of international monetary and fiscal policy issues, such as the choice of an exchange rate regime or the design of a policy coordination scheme, have been conducted with the aid of multi-country econometric models. These studies generally consider alternative policy rules that call for a policy instrument to deviate from some “baseline” reference path in proportion to the deviations of a specified target variable from its own baseline path. This paper argues, however, that the standard rule form is seriously defective and that typical associated measures can be misleading in important cases.

The rule form is defective because it endows policymakers with more information than is available in operational situations and because the baseline reference paths used in such rules are usually model-specific. Policymakers have up-to-date information from financial markets, but high-quality information from goods markets is actually available only with a lag. The paper illustrates the potential difficulties and inappropriate policy conclusions that might follow from typical evaluations of such rules. One example, involving the “assignment problem” of optimally pairing instruments with policy objectives in an open-economy setting, illustrates how the inappropriate choice of performance measures can lead to policies that might appear to satisfy the unsuitable measures but that actually work very badly.

The paper concludes with a discussion of some policy rules that do not suffer from the above defects.

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