Francisco Ruge-Murcia (McGill University): Extreme events and optimal monetary policy

Francisco Ruge-Murcia (McGill University): Extreme events and optimal monetary policy

Co-author: Jinill Kim

Abstract

This paper studies the positive and normative implication of extreme shocks for monetary policy. The analysis is based on a small-scale new Keynesian model with sticky prices and wages where shocks are drawn from asymmetric generalized extreme value (GEV) distributions. A nonlinear perturbation of the model is estimated by the simulated method of moments. Under both the Taylor and Ramsey policies, the central bank responds nonlinearly and asymmetrically to shocks. The trade-o¤ between targeting a gross in.ation rate above as insurance against extreme shocks and strict price stability is unambiguously decided in favour of strict price stability.

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