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Managing uncertainty through robust-satisficing monetary policy

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Author Info
Q. Farooq Akram () (Norges Bank (Central Bank of Norway))
Yakov Ben-Haim (Technion - Israel Institute of Technology)
Øyvind Eitrheim () (Norges Bank (Central Bank of Norway))

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Abstract

We employ information-gap decision theory to derive a robust monetary policy response to Knightian parameter uncertainty. This approach provides a quantitative answer to the question: For a specified policy, how much can our models and data err or vary, without rendering the outcome of that policy unacceptable to a policymaker? For a given acceptable level of performance, the policymaker selects the policy that delivers acceptable performance under the greatest range of uncertainty. We show that such information-gap robustness is a proxy for probability of policy success. Hence, policies that are likely to succeed can be identified without knowing the probability distribution. We adopt this approach to investigate empirically the robust monetary policy response to a supply shock with an uncertain degree of persistence.

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Publisher Info
Paper provided by Norges Bank in its series Working Paper with number 2006/10.

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Length: 33 pages
Date of creation: 23 Oct 2006
Date of revision:
Handle: RePEc:bno:worpap:2006_10

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Related research
Keywords: Knightian uncertainty; Monetary policy; Info-gap decision theory.;

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Leitemo , Kai & Söderström , Ulf, 2005. "Robust monetary policy in a small open economy," Research Discussion Papers 20/2005, Bank of Finland. [Downloadable!]
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  2. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March. [Downloadable!] (restricted)
  3. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April. [Downloadable!] (restricted)
  4. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules under Model Uncertainty," CFS Working Paper Series 2003/06, Center for Financial Studies. [Downloadable!]
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  5. Q. Farooq Akram & Gunnar Bärdsen & Øyvind Eitrheim, 2006. "Monetary policy and asset prices: to respond or not?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(3), pages 279-292. [Downloadable!]
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  6. Hansen, Lars Peter & Maenhout, Pascal & Rustichini, Aldo & Sargent, Thomas J. & Siniscalchi, Marciano M., 2006. "Introduction to model uncertainty and robustness," Journal of Economic Theory, Elsevier, vol. 128(1), pages 1-3, May. [Downloadable!] (restricted)
  7. Lars Peter Hansen & Thomas J. Sargent, 2001. "Acknowledging Misspecification in Macroeconomic Theory," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 519-535, July. [Downloadable!] (restricted)
  8. Epstein, Larry G. & Miao, Jianjun, 2003. "A two-person dynamic equilibrium under ambiguity," Journal of Economic Dynamics and Control, Elsevier, vol. 27(7), pages 1253-1288, May. [Downloadable!] (restricted)
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  9. Adam, Klaus, 2004. "On the relation between robust and Bayesian decision making," Journal of Economic Dynamics and Control, Elsevier, vol. 28(10), pages 2105-2117, September. [Downloadable!] (restricted)
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  10. Alexei Onatski & Noah Williams, 2003. "Modeling Model Uncertainty," NBER Working Papers 9566, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228. [Downloadable!] (restricted)
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  12. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 911-949, June. [Downloadable!] (restricted)
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  13. L. Joe Moffitt & John K. Stranlund & Barry C. Field, 2005. "Inspections To Avert Terrorism: Robustness Under Severe Uncertainty," Working Papers 2005-3, University of Massachusetts Amherst, Department of Resource Economics. [Downloadable!]
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Katerina Smídková & Ales Bulir, 2008. "Striving to Be "Clearly Open" and "Crystal Clear": Monetary Policy Communication of the CNB," IMF Working Papers 08/84, International Monetary Fund. [Downloadable!]
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