When do open economy rules perform badly?
) (Economics Reserve Bank of New Zealand) Abstract When a central bank operates with multiple, non-nested models of the economy, generally no single policy rule will be optimal across within alternate models. In this context, Levin and Williams (2003) introduce the notion of fault tolerance of policy rules, that is, the performance of policy rules when a single element of the rule is misspecified or malfunctioning. Fault tolerance explores straight-forward calculations that illustrate how minimax and Bayesian design rules slant standard rules to take account of potential errors. Mostly, theoretical models developed from optimizing behaviour of agents, predict small and trivial gains to responding to the exchange rate (see Clarida (2001) et al. for example). However, Dennis (2003) argues that models that replicate key characteristics of the data for open economy targeters suggest policymakers should respond to the real exchange rate. This paper explores the fault tolerance of three open
