THE ECONOMETRICS OF MACROECONOMIC MODELLING

# Evaluation of interest rate rules

10.3.1 A new measure—RMSTEs

Since we set the monetary policy instrument RSt in order to make a target variable xt stay close to its target level x*, it makes sense to evaluate the rules according to how well they achieve their objective. In the theoretical literature,

Figure 10.3. Ex post calculations of the implied interest rates from different
interest rate rules over the period 1995(1)-2000(4).

 £(xt — x*)2 = J V [x] + (x — x* )2, t=i

however, policy evaluation is often based on the unconditional variance of xt, denoted V [x]. An alternative measure which puts an equally large weight on the bias of the outcome, that is, on how close the expected value of xt is to the target x*, is the RMSTE. Since the bias could differ considerably between different monetary policy rules, it is of interest to investigate its effect in small samples. If we estimate the expected level E[x] by its sample mean x, the measure can be written as

which is the form we will adopt in the following sections.

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## THE ECONOMETRICS OF MACROECONOMIC MODELLING

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