Optimal Monetary Policy under Risk and Uncertainty
AbstractThis paper seeks to characterise optimal monetary policy rules in the presence of risk and uncertainty. I explore a situation in which the true parameters and the true structure of the economy are unknown to the policymaker, and he is reluctant to make a decision based on a single distribution estimate (i.e. he faces Knightian uncertainty). I show analytically that if the policymaker does not know the true structure of the economy he will be more cautious than in the case of only parameter risk. Further, I show that Knightian uncertainty can also lead to an extra precautionary motive when one considers its interaction with parameter risk. In a simple exercise, I provide empirical estimates that demonstrate that adjustments due to parameter and structural risk and Knightian uncertainty can potentially be quite large.
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Bibliographic InfoArticle provided by Economic Issues in its journal Economic Issues.
Volume (Year): 12 (2007)
Issue (Month): 1 (March)
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- P Arestis & A Mihailov, 2009.
"Flexible Rules cum Constrained Discretion: A New Consensus in Monetary Policy,"
Economic Issues Journal Articles,
Economic Issues, vol. 14(2), pages 27-54, September.
- Philip Arestis & Alexander Mihailov, 2007. "Flexible Rules cum Constrained Discretion: A New Consensus in Monetary Policy," Economic Analysis Research Group Working Papers earg-wp2007-13, Henley Business School, Reading University.
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