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Mr. Tobias Adrian, Vitor Gaspar, and Mr. Francis Vitek
This paper jointly analyzes the optimal conduct of monetary policy, foreign exchange intervention, fiscal policy, macroprudential policy, and capital flow management. This policy analysis is based on an estimated medium-scale dynamic stochastic general equilibrium (DSGE) model of the world economy, featuring a range of nominal and real rigidities, extensive macrofinancial linkages with endogenous risk, and diverse spillover transmission channels. In the pursuit of inflation and output stabilization objectives, it is optimal to adjust all policies in response to domestic and global financial cycle upturns and downturns when feasible—including foreign exchange intervention and capital flow management under some conditions—to widely varying degrees depending on the structural characteristics of the economy. The framework is applied empirically to four small open advanced and emerging market economies.
Mr. Tobias Adrian, Vitor Gaspar, and Mr. Francis Vitek

Table 1. Optimized Policy Rule Response Coefficients Table 2. Financial Cycle Upturn Scenario Assumptions Table 3. Financial Cycle Downturn Scenario Assumptions Table 4. Calibrated Steady State Equilibrium Parameters Table 5. Calibrated Behavioral Parameters Table 6. Calibrated Policy Rule Parameters Table 7. Calibrated Trend Component Parameters Table 8. Calibrated Exogenous Variable Parameters Table 9. Estimated Conditional Variance Function Parameters

Mr. Francis Vitek

variance function are estimated conditional on diffuse priors. The marginal prior distributions of those parameters associated with the conditional mean function are centered within the range of estimates reported in the existing empirical literature, where available. Tight priors are imposed on a subset of these structural parameters to ensure the existence of a unique stationary rational expectations equilibrium. The marginal prior distributions of the monetary policy rule response coefficients represent a flexible inflation targeting regime for all economies except

Mr. Tobias Adrian, Vitor Gaspar, and Mr. Francis Vitek

eliminate its dependence on initial conditions. Finally, we numerically minimize this average intertemporal loss function, jointly with respect to the response coefficients of the relevant policy rules, subject to inequality constraints on them. The optimized policy rule response coefficients are all positive, as shown in Table 1. This absence of corner solutions implies that all of the policies under consideration should be systematically used to help stabilize inflation and output in our framework, on average across states of the world economy. Across the economies

Mr. Tobias Adrian and Mr. Francis Vitek
We augment a linearized dynamic stochastic general equilibrium (DSGE) model with a tractable endogenous risk mechanism, to support the joint analysis of monetary and macroprudential policy. This state dependent conditional heteroskedasticity mechanism specifies the conditional variances of structural shocks as functions of the business or financial cycle. The resultant heteroskedastic linearized DSGE model preserves the satisfactory simulation and forecasting performance of its nested homoskedastic counterpart for the conditional means of endogenous variables, while substantially improving its goodness of fit to their conditional distributions. In particular, the model matches the key stylized facts of growth at risk. Accounting for state dependent conditional heteroskedasticity makes it optimal for monetary policy to respond more aggressively to the business cycle, and for macroprudential policy to manage the resilience of the banking sector more actively over the financial cycle.
Mr. Tobias Adrian and Mr. Francis Vitek

linearized DSGE model to exhibit state dependent conditional heteroskedasticity makes it optimal for monetary policy to respond more aggressively to the business cycle, and for macroprudential policy to manage the resilience of the banking sector to systemic risk more actively over the financial cycle. Indeed, the optimized values of the relevant monetary and macroprudential policy rule response coefficients are all larger. The intuition for this result is straightforward. Our state dependent conditional heteroskedasticity mechanism amplifies the volatility of the economy

Mr. Francis Vitek
This paper develops a panel unobserved components model of the monetary transmission mechanism in the world economy, disaggregated into its fifteen largest national economies. This structural macroeconometric model features extensive linkages between the real and financial sectors, both within and across economies. A variety of monetary policy analysis and forecasting applications of the estimated model are demonstrated, based on a novel Bayesian framework for conditioning on judgment.