Parameter Instability, Model Uncertainty and the Choice of Monetary Policy

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Parameter Instability, Model Uncertainty and the Choice of Monetary Policy

Author Info

Carlo Favero (IGIER, Bocconi University and CEPR)
Fabio Milani (Princeton University)

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Abstract

This paper starts from the observation that parameter instability and model uncertainty are relevant problems for the analysis of monetary policy in small macroeconomic models. We propose to deal with these two problems by implementing a novel "thick recursive modelling" approach. At each point in time we estimate all models generated by the combinations of a base-set of k observable regressors for aggregate demand and supply. We compute optimal monetary policies for all possible models and then consider alternative ways of summarizing their distribution. Our main results show that thick recursive modelling delivers optimal policy rates that track the observed policy rates better than the optimal policy rates obtained under a constant parameter specification with no role for model uncertainty.

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Article provided by Berkeley Electronic Press in its journal Topics in Macroeconomics.

Volume (Year): 5 (2005)
Issue (Month): 1 ()
Pages: 1208-1208
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Handle: RePEc:bep:mactop:v:5:y:2005:i:1:p:1208-1208

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Paper
- Favero, Carlo A & Milani, Fabio, 2005. "Parameter Instability, Model Uncertainty and the Choice of Monetary Policy," CEPR Discussion Papers 4909, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Fabio Milani, 2004. "Monetary Policy with a Wider Information Set: a Bayesian Model Averaging Approach," Macroeconomics 0401004, EconWPA. [Downloadable!]
Other versions:
- Fabio Milani, 2008. "Monetary Policy With A Wider Information Set: A Bayesian Model Averaging Approach," Scottish Journal of Political Economy, Scottish Economic Society, vol. 55(1), pages 1-30, 02. [Downloadable!] (restricted)
Arnulfo Rodriguez & Pedro N. Rodriguez, 2006. "Recursive Thick Modeling and the Choice of Monetary Policy in Mexico," Computing in Economics and Finance 2006 30, Society for Computational Economics. [Downloadable!]

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