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A Bayesian approach to optimal monetary policy with parameter and model uncertainty

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Author Info

  • Cogley, Timothy
  • De Paoli, Bianca
  • Matthes, Christian
  • Nikolov, Kalin
  • Yates, Tony

Abstract

This paper undertakes a Bayesian analysis of optimal monetary policy for the U.K. We estimate a suite of monetary-policy models that include both forward- and backward-looking representations as well as large- and small-scale models. We find an optimal simple Taylor-type rule that accounts for both model and parameter uncertainty. For the most part, backward-looking models are highly fault tolerant with respect to policies optimized for forward-looking representations, while forward-looking models have low fault tolerance with respect to policies optimized for backward-looking representations. In addition, backward-looking models often have lower posterior probabilities than forward-looking models. Bayesian policies therefore have characteristics suitable for inflation and output stabilization in forward-looking models.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 12 ()
Pages: 2186-2212

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:12:p:2186-2212

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Monetary policy; Bayesian analysis; Statistical decision theory; Quantitative policy modeling;

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References

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  1. Lars Svensson & Noah Williams, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," NBER Working Papers 11733, National Bureau of Economic Research, Inc.
  2. George Kapetanios & Vincent Labhard & Simon Price, 2006. "Forecasting using Bayesian and Information Theoretic Model Averaging: An Application to UK Inflation," Working Papers 566, Queen Mary, University of London, School of Economics and Finance.
  3. Brock,W.A. & Durlauf,S.N. & West,K.D., 2004. "Model uncertainty and policy evaluation : some theory and empirics," Working papers 19, Wisconsin Madison - Social Systems.
  4. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
  5. Timothy Cogley & Riccardo Colacito & Thomas J. Sargent, 2007. "Benefits from U.S. Monetary Policy Experimentation in the Days of Samuelson and Solow and Lucas," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 67-99, 02.
  6. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  7. Timothy Cogley & Riccardo Colacito & Lars Peter Hansen & Thomas J. Sargent, 2008. "Robustness and U.S. Monetary Policy Experimentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1599-1623, December.
  8. Levine, Paul & McAdam, Peter & Pearlman, Joseph G. & Pierse, Richard, 2008. "Risk Management in Action. Robust monetary policy rules under structured uncertainty," Working Paper Series 0870, European Central Bank.
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Citations

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Cited by:
  1. Federico Ravenna, 2014. "How Central Banks Learn the True Model of the Economy," Cahiers de recherche 1409, CIRPEE.
  2. Gradojevic, Nikola & Gençay, Ramazan, 2013. "Fuzzy logic, trading uncertainty and technical trading," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 578-586.
  3. Francesca Rondina, 2010. "The role of model uncertainty and learning in the U.S. postwar policy response to oil prices," Working Papers 478, Barcelona Graduate School of Economics.
  4. Rondina, Francesca, 2012. "The role of model uncertainty and learning in the US postwar policy response to oil prices," Journal of Economic Dynamics and Control, Elsevier, vol. 36(7), pages 1009-1041.
  5. Ravenna, Federico, 2012. "Optimal monetary policy and model selection in a real-time learning environment," Economics Letters, Elsevier, vol. 114(3), pages 322-325.
  6. Polito, Vito & Spencer, Peter, 2011. "UK Macroeconomic Volatility and the Welfare Costs of Inflation," Cardiff Economics Working Papers E2011/23, Cardiff University, Cardiff Business School, Economics Section.
  7. Francesca Rondina, 2010. "Policy Evaluation and Uncertainty About the Effects of Oil Prices on Economic Activity," Working Papers 522, Barcelona Graduate School of Economics.

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