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Model Uncertainty, Robust Policies, And The Value Of Commitment

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  • Kasa, Kenneth

Abstract

Using results from the literature on H control, this paper incorporates model uncertainty into a frequency-domain approach to stabilization policy. The derived policies guarantee a minimum performance level even in the worst of (a bounded set of) circumstances. Robust H policies are shown to be more activist than H2 policies in the sense that their impulse responses are larger. Robust policies also tend to be more autocorrelated. Consequently, the premium associated with being able to commit is greater under model uncertainty. Without commitment, the policymaker is not able to (credibly) smooth his response to the degree that he would like. A contribution of this paper is its analysis of robust control in a model featuring a forward-looking state transition equation, which arises from the fact that the private sector bases its decisions on expectations of future government policy. Existing applications of H control in economics follow the engineering literature, and only consider backward-looking state transition equations.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 6 (2002)
Issue (Month): 01 (February)
Pages: 145-166

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Handle: RePEc:cup:macdyn:v:6:y:2002:i:01:p:145-166_02

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References

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  1. Kenneth Kasa, 1994. "Optimal policy with limited commitment," Working Papers in Applied Economic Theory 94-16, Federal Reserve Bank of San Francisco.
  2. Marcellino, Massimiliano & Salmon, Mark, 2002. "Robust Decision Theory And The Lucas Critique," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 167-185, February.
  3. William Roberds, 1986. "Models of policy under stochastic replanning," Staff Report 104, Federal Reserve Bank of Minneapolis.
  4. Taylor, John B, 1975. "Monetary Policy during a Transition to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 83(5), pages 1009-21, October.
  5. V.V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans and mutual default," Staff Report 124, Federal Reserve Bank of Minneapolis.
  6. Oliner, Stephen D. & Rudebusch, Glenn D. & Sichel, Daniel, 1996. "The Lucas critique revisited assessing the stability of empirical Euler equations for investment," Journal of Econometrics, Elsevier, vol. 70(1), pages 291-316, January.
  7. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
  8. Lars Peter Hansen & Thomas J. Sargent, 1979. "Formulating and estimating dynamic linear rational expectations models," Working Papers 127, Federal Reserve Bank of Minneapolis.
  9. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 627-656, October.
  10. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  11. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  12. Christopher A. Sims, 1982. "Policy Analysis with Econometric Models," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(1), pages 107-164.
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Citations

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Cited by:
  1. Luo, Yulei & Nie, Jun & Young, Eric, 2014. "Model Uncertainty and Intertemporal Tax Smoothing," MPRA Paper 54268, University Library of Munich, Germany.
  2. Martin Ellison & Thomas J. Sargent, 2012. "A Defense Of The Fomc," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(4), pages 1047-1065, November.
  3. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 581-604, April.
  4. Brock, William A. & Durlauf, Steven N., 2005. "Local robustness analysis: Theory and application," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 2067-2092, November.
  5. 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, vol. 25(6-7), pages 911-949, June.
  6. Dennis, Richard, 2014. "Imperfect credibility and robust monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 44(C), pages 218-234.
  7. Marc Giannoni, 2006. "Robust Optimal Policy in a Forward-Looking Model with Parameter and Shock Uncertainty," NBER Working Papers 11942, National Bureau of Economic Research, Inc.
  8. Hansen, Lars Peter & Mayer, Ricardo & Sargent, Thomas, 2010. "Robust hidden Markov LQG problems," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 1951-1966, October.
  9. Kenneth Kasa, 2000. "A robust Hansen-Sargent prediction formula," Working Paper Series 2000-11, Federal Reserve Bank of San Francisco.

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