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Monetary policy under uncertainty: Min-max vs robust-satisficing strategies

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Abstract

We study monetary policy under uncertainty. A policy which ameliorates a worst case may differ from a policy which maximizes robustness and satisfices the performance. The former strategy is min-maxing and the latter strategy is robust-satisficing. We show an “observational equivalence” between robust-satisficing and min-maxing. However, there remains a “behavioral difference” between robust-satisficing and min-maxing. Policy makers often wish to respect specified bounds on target variables. The robust-satisficing policy can be more (and is never less) robust, and hence more dependable, than the min-max policy. We illustrate this in an empirical example where monetary policy making amounts to selecting the coefficients of a Taylor-type interest rate rule, subject to uncertainty in the persistence of shocks to inflation.

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File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2007/WP-20076/
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Paper provided by Norges Bank in its series Working Paper with number 2007/06.

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Length: 28 pages
Date of creation: 05 Dec 2007
Date of revision:
Handle: RePEc:bno:worpap:2007_06

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Keywords: Knightian uncertainty; robustness; info-gap decision theory; monetary policy; minmax policy; robust-satisficing policy.;

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