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Elements of a Theory of Design Limits to Optimal Policy

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  • William A. Brock
  • Steven N. Durlauf

Abstract

This paper presents a framework for understanding the limits that exist in optimal policy design in dynamic contexts. We consider the design of policies in the context of dynamic linear models. Fundamental design limits exist for policy rules in such environments in the sense that any policy rule embodies tradeoffs between the magnitudes of different frequency-specific components of the variance. Hence policies that are effective in eliminating low frequency variance components of a state variable can only do so at the cost of exacerbating high frequency variance components, and vice versa. Examples of the implications of such tradeoffs are considered. Copyright Blackwell Publishing Ltd and The Victoria University of Manchester, 2004.

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Bibliographic Info

Article provided by University of Manchester in its journal The Manchester School.

Volume (Year): 72 (2004)
Issue (Month): s1 (09)
Pages: 1-18

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Handle: RePEc:bla:manchs:v:72:y:2004:i:s1:p:1-18

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  1. Barsky, Robert B & Miron, Jeffrey A, 1989. "The Seasonal Cycle and the Business Cycle," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(3), pages 503-34, June.
  2. Athanasios Orphanides & John C. Williams, 2002. "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 63-146.
  3. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 25(6-7), pages 911-949, June.
  4. Otrok, C. & Ravikumar, B. & Whiteman, C., 1998. "Habit Formation: A Resolution of the Equity Premium Puzzle?," Working Papers, University of Iowa, Department of Economics 98-04, University of Iowa, Department of Economics.
  5. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(3), pages 581-604, April.
  6. William A. Brock & Steven N. Durlauf & Kenneth D. West, 2003. "Policy Evaluation in Uncertain Economic Environments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 235-322.
  7. Lars Peter Hansen & Thomas J. Sargent, 2001. "Acknowledging Misspecification in Macroeconomic Theory," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 519-535, July.
  8. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 6(01), pages 111-144, February.
  9. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, July.
  10. Alexei Onatski & James H. Stock, 1999. "Robust monetary policy under model uncertainty in a small model of the U.S. economy," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  11. Alexei Onatski & Noah Williams, 2003. "Modeling Model Uncertainty," Journal of the European Economic Association, MIT Press, MIT Press, vol. 1(5), pages 1087-1122, 09.
  12. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  13. Mark Salmon & Massimiliano Marcellino, 2001. "Robust Decision Theory and the Lucas Critique," Working Papers, Warwick Business School, Finance Group wp01-10, Warwick Business School, Finance Group.
  14. Christopher A. Sims, 2001. "Pitfalls of a Minimax Approach to Model Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 51-54, May.
  15. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
  16. Otrok, Christopher, 2001. "Spectral Welfare Cost Functions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 345-67, May.
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Citations

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Cited by:
  1. Yu, Xiangrong, 2013. "Measurement error and policy evaluation in the frequency domain," Journal of Macroeconomics, Elsevier, Elsevier, vol. 38(PB), pages 307-329.
  2. William A. Brock & Steven N. Durlauf & Kenneth D. West, 2004. "Model Uncertainty and Policy Evaluation: Some Theory and Empirics," NBER Working Papers 10916, National Bureau of Economic Research, Inc.
  3. Brock, William A. & Durlauf, Steven N. & Rondina, Giacomo, 2013. "Design limits and dynamic policy analysis," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(12), pages 2710-2728.
  4. Pataracchia, Beatrice, 2011. "The spectral representation of Markov switching ARMA models," Economics Letters, Elsevier, Elsevier, vol. 112(1), pages 11-15, July.
  5. Beatrice Pataracchia, 2008. "Design Limits in Regime-Switching Cases," Department of Economics University of Siena, Department of Economics, University of Siena 529, Department of Economics, University of Siena.
  6. Travaglini, Guido, 2007. "The U.S. Dynamic Taylor Rule With Multiple Breaks, 1984-2001," MPRA Paper 3419, University Library of Munich, Germany, revised 15 Jun 2007.
  7. Brock, William A. & Durlauf, Steven N. & Nason, James M. & Rondina, Giacomo, 2007. "Simple versus optimal rules as guides to policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(5), pages 1372-1396, July.
  8. Brock, William A. & Durlauf, Steven N., 2005. "Local robustness analysis: Theory and application," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(11), pages 2067-2092, November.
  9. Anastasios Xepapadeas & Giannis Vardas, 2004. "Uncertainty Aversion, Robust Control and Asset Holdings," Working Papers, Fondazione Eni Enrico Mattei 2004.66, Fondazione Eni Enrico Mattei.
  10. Brock,W.A. & Durlauf,S.N., 2004. "Macroeconomics and model uncertainty," Working papers, Wisconsin Madison - Social Systems 20, Wisconsin Madison - Social Systems.
  11. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion and Robust Portfolio Choices," Working Papers, University of Crete, Department of Economics 0408, University of Crete, Department of Economics.

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