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Welfare-maximizing monetary policy under parameter uncertainty

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Author Info
Rochelle M. Edge
Thomas Laubach
John C. Williams

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Abstract

This paper examines welfare-maximizing monetary policy in an estimated dynamic stochastic general equilibrium model of the U.S. economy where the policymaker faces uncertainty about the true values of model parameters. Uncertainty about parameters describing preferences and technology implies not only uncertainty about the dynamics of the economy. In addition, it implies uncertainty about the model's utility-based welfare criterion and model dynamics but also uncertainty about the "natural" rate of output that the central bank should aim to achieve absent nominal rigidities and the natural rate of interest that is consistent with this level of output equalling its natural rate absent nominal rigidities. We analyze the characteristics and performance of alternative monetary policy rules given the estimated uncertainty regarding parameter estimates. We find that the natural rates of interest and output are imprecisely estimated. We then show that optimal policies under parameter uncertainty respond primarily to indirect signals regarding natural rates extracted from observed prices and wages and the level of hours.

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

Volume (Year): (2007)
Issue (Month): ()
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Handle: RePEc:fip:fedfpr:y:2007:x:2

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Keywords: Monetary policy

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References listed on IDEAS
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  1. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
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  4. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary policy under uncertainty in micro-founded macroeconometric models," Working Papers in Applied Economic Theory 2005-15, Federal Reserve Bank of San Francisco. [Downloadable!]
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  8. Jordi Gali, 1999. "Technology, Employment, and the Business Cycle: Do Technology Shocks Explain Aggregate Fluctuations?," American Economic Review, American Economic Association, vol. 89(1), pages 249-271, March. [Downloadable!] (restricted)
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  9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39, pages 195-214, December. [Downloadable!] (restricted)
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  13. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  14. Thomas Laubach & John C. Williams, 2003. "Measuring the Natural Rate of Interest," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1063-1070, November. [Downloadable!] (restricted)
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  15. Lawrence J. Christiano & Martin Eichenbaum & Robert Vigfusson, 2006. "Assessing Structural VARs," NBER Working Papers 12353, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Athanasios Orphanides & John C. Williams, 2006. "Monetary Policy with Imperfect Knowledge," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 366-375, 04-05. [Downloadable!] (restricted)
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  17. Matthew D. Shapiro & Mark W. Watson, 1988. "Sources of Business Cycle Fluctuations," Cowles Foundation Discussion Papers 870, Cowles Foundation, Yale University. [Downloadable!]
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  18. Frederico S. Finan & Robert Tetlow, 1999. "Optimal control of large, forward-looking models efficient solutions and two examples," Finance and Economics Discussion Series 1999-51, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  22. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December. [Downloadable!] (restricted)
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