Monetary policy rules under model uncertainty

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The research proposal outlines a consistent methodology to investigate the evolution of monetary policy using Bayesian inference and lies in the intersection of the fields of applied monetary economics, computational statistics and Bayesian econometrics. The main research question is whether there is significant evidence of a generalised type of monetary policy rule which might potentially vary over time that can explain how the monetary policy stance is determined by a central bank. The research question is addressed gradually and can be divided in the following 4 questions. The first 3 questions assume that the single monetary policy instrument that is used under normal times is the interest rates. The 4th re-examines the determinants of monetary policy by taking into consideration unconventional measures such as quantitative easing when interest rates cannot be decreased further down to the negative territory and hit the Zero Lower Bound (ZLB). 1. Assuming a generalised monetary policy rule has constant parameters over time, which are the macroeconomic and financial variables that have the largest explanatory power on the short-term interest rates? 2. Dropping the assumption of constant parameters and allowing for Time Varying Parameters (TVP), is there a generalised monetary policy rule which best describes the conduct of monetary policy using the short-term interest rates instrument? 3. Allowing both for structural instability of the parameters of the explanatory variables and time varying probabilities of the generalised monetary policy rules models' space, is there statistical evidence of when: 3.a Monetary policy changed from backward looking to forward looking? 3.b Monetary authorities adjusted their policy rules to account for the updated mandate on financial stability? 4. Assuming the entire monetary policy stance is captured by the shadow rate, i.e. quantifying the effect of asset purchasing programmes when central banks' balance sheet expansion occurs to an equivalent unconstrained interest rate index, which are the determinants that can best explain the shadow rate along the lines of the methodology followed from questions 1 to 3? The outcome of answering these questions will improve substantially our understanding of the real process of monetary policy making in the past and will provide analytical tools for predicting the evolution of the short-term rates and foreign exchange rates following Taylor rule fundamentals. The in-sample performance of Bayesian Model Averaging (BMA) and Dynamic Model Averaging (DMA) methodologies and their by-product, i.e. variable selection, will provide sufficient evidence of whether the actual policy making process follows a normative approach as described by the theoretical explanatory framework of inflation and output gap or indeed there are further factors that are taken into consideration inadvertently or not, taking into account all the available policy instruments, both conventional and unconventional.