Ex-Post Evaluation of Monetary Policy

We employ a model-based approach in an ex-post evaluation of monetary policy decisions taken by the Bank of Israel during the years 2001-2010. Using ex-post information, we test, for each individual year, whether there could have been a Pareto improvement in ination and output volatilities. This involves simulating counterfactual scenarios under alternative monetary policy shocks, where for each such simulation we compute the Root Mean Squares (RMS) of the ination and output gaps during and following the evaluated year. We then examine the deviation of actual RMS from simulation-based frontiers. We also compare the actual RMS to a counterfactual RMS which would have been obtained for the case of no policy shocks. In other words, we test whether actual policy shocks were "e¢ cient". The exercise reveals several distinct sets of years: years in which actual RMSs were close to the e¢ cient frontier (2001 and 2009) and years in which they were far away (2003, 2004 and 2006); years in which monetary policy shocks led to an absolute improvement in economic outcomes (2004 and 2008) or an absolute worsening (2003, 2006); and years characterized by aggressive policy shocks (2002, 2008 and 2009), which were usually aimed at narrowing the output gap at the expense of more volatile ination.