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Robust estimation and monetary policy with unobserved structural change

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  • John C. Williams

Abstract

This paper considers the joint problem of model estimation and implementation of monetary policy in the face of uncertainty regarding the process of structural change in the economy. I model unobserved structural change through time variation in the natural rates of interest and unemployment. I show that certainty equivalent optimal policies perform poorly when there is model uncertainty about the natural rate processes. I then examine the properties of combined estimation methods and policy rules that are robust to this type of model uncertainty. I find that weighted averages of sample means perform well as estimators of natural rates. The optimal policy under uncertainty responds more aggressively to inflation and less so to the perceived unemployment gap than the certainty equivalent policy. This robust estimation/policy combination is highly effective at mitigating the effects of natural rate mismeasurement.

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Bibliographic Info

Article provided by Federal Reserve Bank of San Francisco in its journal Economic Review.

Volume (Year): (2006)
Issue (Month): ()
Pages: 1-16

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Handle: RePEc:fip:fedfer:y:2006:p:1-16

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Keywords: Monetary policy ; Econometric models ; Unemployment ; Inflation (Finance);

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References

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Cited by:
  1. Athanasios Orphanides & John C. Williams, 2005. "Monetary policy with imperfect knowledge," Finance and Economics Discussion Series 2005-51, Board of Governors of the Federal Reserve System (U.S.).
  2. Athanasios Orphanides & John C. Williams, 2006. "Inflation targeting under imperfect knowledge," Finance and Economics Discussion Series 2006-20, Board of Governors of the Federal Reserve System (U.S.).
  3. Ippei Fujiwara & Naoko Hara & Naohisa Hirakata & Takeshi Kimura & Shinichiro Watanabe, 2007. "Japanese Monetary Policy during the Collapse of the Bubble Economy: A View of Policy-making under Uncertainty," IMES Discussion Paper Series 07-E-09, Institute for Monetary and Economic Studies, Bank of Japan.
  4. Athanasios Orphanides & John C. Williams, 2007. "Robust monetary policy with imperfect knowledge," Finance and Economics Discussion Series 2007-33, Board of Governors of the Federal Reserve System (U.S.).
  5. Richard A. Ashley. & Randall J. Verbrugge., 2006. "Mis-Specification and Frequency Dependence in a New Keynesian Phillips Curve," Working Papers e06-12, Virginia Polytechnic Institute and State University, Department of Economics.
  6. Richard A. Ashley & Randall J. Verbrugge., 2006. "Mis-Specification in Phillips Curve Regressions: Quantifying Frequency Dependence in This Relationship While Allowing for Feedback," Working Papers e06-11, Virginia Polytechnic Institute and State University, Department of Economics.

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