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Welfare-maximizing monetary policy under parameter uncertainty

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  • Rochelle M. Edge

    (Board of Governors of the Federal Reserve System, Washington, DC, USA)

  • Thomas Laubach

    (Goethe University Frankfurt, Germany)

  • John C. Williams

    (Federal Reserve Bank of San Francisco, CA, USA)

Abstract

This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the US economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies uncertainty about the model's dynamics, utility-based welfare criterion and the 'natural' rates of output and interest that would prevail absent nominal rigidities. We estimate the degree of uncertainty regarding natural rates due to parameter uncertainty. We find that optimal Taylor rules under parameter uncertainty respond less to the output gap and more to price inflation than would be optimal absent parameter uncertainty. We also show that policy rules that focus solely on stabilizing wages and prices yield welfare outcomes very close to the first-best. Copyright © 2009 John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 25 (2010)
Issue (Month): 1 ()
Pages: 129-143

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Handle: RePEc:jae:japmet:v:25:y:2010:i:1:p:129-143

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Citations

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Cited by:
  1. Carl Walsh, 2007. "Inflation Targeting and the Role of Real Objectives," Research and Policy Notes 2007/02, Czech National Bank, Research Department.
  2. André P. Calmon & Thomas Vallée & João B. R. Do Val, 2009. "Monetary policy as a source of uncertainty," Working Papers hal-00422454, HAL.
  3. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2007. "Welfare-maximizing monetary policy under parameter uncertainty," Finance and Economics Discussion Series 2007-56, Board of Governors of the Federal Reserve System (U.S.).
  4. Paez-Farrell, Juan, 2014. "Resuscitating the ad hoc loss function for monetary policy analysis," Economics Letters, Elsevier, vol. 123(3), pages 313-317.
  5. Sala, Luca & Söderström, Ulf & Trigari, Antonella, 2008. "Monetary Policy Under Uncertainty in an Estimated Model with Labour Market Frictions," CEPR Discussion Papers 6826, C.E.P.R. Discussion Papers.
  6. Williams, John C., 2013. "A defense of moderation in monetary policy," Journal of Macroeconomics, Elsevier, vol. 38(PB), pages 137-150.
  7. Pei-Tha Gan, 2014. "The Optimal Economic Uncertainty Index: A Grid Search Application," Computational Economics, Society for Computational Economics, vol. 43(2), pages 159-182, February.
  8. Avouyi-Dovi, S. & Sahuc, J-G., 2011. "On the Welfare Costs of Misspecified Monetary Policy Objectives," Working papers 320, Banque de France.

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