Confidence in Monetary Policy
AbstractIn situations of relative calm and certainty, policy makers have confidence in the mechanisms at work and feel capable of attaining precise and ambitious results. As the environment becomes less and less certain, policy makers are confronted with the fact that there is a trade-off between the quality of a certain outcome and the confidence (robustness) with which it can be attained. Added to that, in the presence of Knightian uncertainty, confidence itself can no longer be represented in probabilistic terms (because probabilities are unknown). We adopt the technique of Info-Gap Robust Satisficing to first define confidence under Knightian uncertainty, and second quantify the trade-off between quality and robustness explicitly.We apply this to a standard monetary policy example and provide Central Banks with a framework to rank policies in a way that will allow them to pick the one that either maximizes confidence given an acceptable level of performance, or alternatively, optimizes performance for a given level of confidence.
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Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 192.
Date of creation: Dec 2008
Date of revision:
Knightian Uncertainty; Satisficing; Bounded Rationality; Minmax;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-12-21 (All new papers)
- NEP-CBA-2008-12-21 (Central Banking)
- NEP-CBE-2008-12-21 (Cognitive & Behavioural Economics)
- NEP-MAC-2008-12-21 (Macroeconomics)
- NEP-MON-2008-12-21 (Monetary Economics)
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