A new monetary policy rule for CEFM : New monetary policy rule for Canadian Economic and Fiscal Model

The structure of this rule is simple and tractable and yet it captures the essence of the behaviour of the monetary authority. [...] To avoid the estimation problems, the choice of parameters in a Taylor-type rule typically depend less on estimated results but more on how the rule interacts with the rest of the model in a way that is consistent with the preferences of policy makers. [...] Factors such as the persistence of prices and output, the interest-rate elasticity of demand, the degree of openness, and the form of expectations influence the optimal choice of parameters. [...] We therefore include the second shock to ensure that the source of the shock would not alter the ranking of the rules. [...] The deviations of the inflation gap and the output gap from control levels work together through the monetary policy rule to raise the short-term interest rate.