The paper compares the main alternative monetary policy strategies to assess which one performs best in terms of both minimising the volatility of inflation and the output-gap and reducing the probability of falling into a liquidity trap. The strategies differ in the degree of history dependence and are assessed by means of a three-equation New Keynesian DSGE model, which is estimated with Bayesian methods on euro-area data. Only optimal rules are considered for each strategy.
The main finding of the paper is that monetary policy strategies exhibiting a higher degree of history dependence perform best: price-level targeting is superior to all the others; nominal GDP-level targeting is second best. Similar results are obtained when the loss function of the central bank includes among its arguments the volatility of the policy rate. Sensitivity analyses show that the ranking of monetary policy strategies is not affected by changes in model parameters.
