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Welfare-Maximizing Monetary Policy Under Parameter Uncertainty

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  • Rochelle M. Edge

    ()

  • Thomas Laubach

    ()

  • John C. Williams

    ()

Abstract

This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the U.S. 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.

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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2008-16.

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Length: 45 pages
Date of creation: May 2008
Date of revision:
Handle: RePEc:een:camaaa:2008-16

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Citations

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Cited by:
  1. Thomas Laubach & John C. Williams & Rochelle M. Edge, 2007. "Welfare-Maximizing Monetary Policy under Parameter Uncertainty," 2007 Meeting Papers 311, Society for Economic Dynamics.
  2. Paez-Farrell, Juan, 2014. "Resuscitating the ad hoc loss function for monetary policy analysis," Economics Letters, Elsevier, vol. 123(3), pages 313-317.
  3. Williams, John C., 2013. "A defense of moderation in monetary policy," Journal of Macroeconomics, Elsevier, vol. 38(PB), pages 137-150.
  4. Sala, Luca & Söderström, Ulf & Trigari, Antonella, 2008. "Monetary policy under uncertainty in an estimated model with labor market frictions," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 983-1006, July.
  5. 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.
  6. Avouyi-Dovi, Sanvi & Sahuc, Jean-Guillaume, 2011. "On the welfare costs of misspecified monetary policy objectives," Economics Papers from University Paris Dauphine 123456789/11154, Paris Dauphine University.
  7. Carl Walsh, 2007. "Inflation Targeting and the Role of Real Objectives," Research and Policy Notes 2007/02, Czech National Bank, Research Department.
  8. André P. Calmon & Thomas Vallée & João B. R. Do Val, 2009. "Monetary policy as a source of uncertainty," Working Papers hal-00422454, HAL.

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