Prof Oliver de Groot, in collaboration with the economists at the European Central Bank (ECB), is developing novel methods and tools for studying the optimal mix of central bank policy instruments, suitable for informing policymakers with the aim of improving monetary policy decisions. The underlying research from this collaboration is currently being used to impact policy making at the ECB. More recently, engagement with policy economists at other central banks, including, for example, the Bank of Canada, will result in more widespread benefits in the form of better monetary policy across several economies.
Background
Before 2008, monetary policy decisions revolved almost exclusively around the setting of the nominal short-term interest rate and research-based policy advice invariably came from stylized linear models with a single policy instrument. Since then, the setting of monetary policy has become decidedly more challenging. With interest rates across the globe at historically low levels, policy makers have been constrained in the use of the nominal interest rate to set policy and have had to resort to a suite of non-standard measures. At the same time, the financial crisis of 2008 and the covid crisis of 2020 have highlighted powerful nonlinear forces that operate on economies. The combination of multiple policy instruments and important nonlinearities pose both computational challenges for the academic study of monetary policy and practical challenges for policymakers when setting policy.
Research
Professor de Groot, in collaboration with economists at the ECB have developed novel methods and tools for studying optimal monetary policy in an environment with multiple policy instruments and powerful nonlinearities. The rigorous underlying research is currently summarized in three research papers—Christoffel et al. (2020), de Groot & Mazelis (2020), and de Groot et al. (2021 forthcoming). The latter paper presents a toolkit for studying optimal policy using a minimal set of inputs consisting of a baseline forecast, a policy objective, and impulse response functions to anticipated policy instrument shocks. With these three inputs, the toolkit can derive the optimal prescription for policy under numerous scenarios including commitment, limited commitment, and discretion; numerous constraints on policy; and alternative methods for solving the forward guidance puzzle. The former two papers provide the methodology for resolving the forward guidance puzzle that plagues most large-scale models used by policy institutions and provides an empirical methodology for disciplining the key inattention parameter, respectively.
Impact
The novel methods and tools described above are currently being used by ECB staff when briefing and advising ECB Council Members and Eurosystem National Central Banks. In addition, the University of Liverpool hosted a conference on “Optimal Monetary Policy: Computational Advances and their Applications” in early 2021, bringing together both academic scholars and central bank practitioners. The conference speakers and participants came from across the international central banking community including the Bank of Canada, Bank of Ireland, Bank of Italy, ECB, Federal Reserve Board, and Norges Bank. The conference highlighted the challenges faced by central banks in setting policy and showcasing computational advances in tools for studying optimal policy in practice. The conference led to significant interest from various central banks in the methods and tools developed by Prof de Groot and his collaborators. A Special Issue of the Journal of Macroeconomics, guest-edited and with a summary article by Prof de Groot (de Groot & Motto, 2021 forthcoming), is scheduled for publication later in 2021, further helping to facilitate the link between rigorous academic research and practical policy impact.
Ongoing Research
Professor de Groot continues to collaborate with the ECB and is in discussions with other national central banks in Europe and North America regarding the use of these new tools for advising monetary policy decision makers. Further advances and development of the tools are planned for the coming years.
Related Research Output
- Kai Christoffel, Oliver de Groot, Falk Mazelis, & Carlos Montes-Galdón (2020). “Using forecast-augmented VAR evidence to dampen the forward guidance puzzle”, ECB working paper No 2495
- Oliver de Groot & Falk Mazelis (2020). “Mitigating the forward guidance puzzle: inattention, credibility, finite planning horizons and learning”, ECB working paper No 2426
- Oliver de Groot, Falk Mazelis, Roberto Motto & Annukka Ristiniemi (2021). “A Toolkit for Computing Constrained Optimal Policy Projections (COPPs)”, forthcoming as an ECB working paper
- Oliver de Groot & Roberto Motto (2021). “Computational Advances in the Study of Optimal Monetary Policy and its Applications: An Overview”, forthcoming Journal of Macroeconomics.
Professor Oliver de Groot
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