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Robust estimation and monetary policy with unobserved structural change

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Author Info
John C. Williams

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Abstract

This paper considers the monetary policymaker’s joint problem of model estimation and the design of a policy rule in the face of uncertainty regarding the process of structural change in the economy. Unobserved structural change is modeled through time variation in the natural rates of interest and unemployment. I show that certainty-equivalent optimal policies perform poorly when there is uncertainty about the natural rate processes. I then examine the properties of combined estimation methods and policy rules that are robust to this type of model uncertainty. I find that weighted sample means are robust estimators of natural rates for the purpose of setting policy. The optimal policy under uncertainty incorporates a significant degree of policy inertia and a muted response to the perceived unemployment gap; by comparison, the certainty-equivalent optimized policy in this model exhibits little policy inertia and a more aggressive response to the unemployment gap.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 2004-11.

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Date of creation: 2004
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Handle: RePEc:fip:fedfap:2004-11

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Keywords: Monetary policy ; Econometric models;

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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.:
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  5. Levin, Andrew T. & Williams, John C., 2003. "Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 945-975, July. [Downloadable!] (restricted)
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  11. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12. [Downloadable!]
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  13. Athanasios Orphanides & John C. Williams, 2003. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Working Papers 9884, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. A. Orphanides & J. Williams, 2003. "The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations," Proceedings, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  15. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2004. "Learning and shifts in long-run productivity growth," Working Papers in Applied Economic Theory 2004-04, Federal Reserve Bank of San Francisco. [Downloadable!]
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  16. 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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  17. Andrew Levin & Volker Wieland & John C. Williams, 1998. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Working Papers 6570, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  27. Marianne Baxter & Robert G. King, 1999. "Measuring Business Cycles: Approximate Band-Pass Filters For Economic Time Series," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 575-593, November. [Downloadable!] (restricted)
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  28. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Papers in Applied Economic Theory 2003-01, Federal Reserve Bank of San Francisco. [Downloadable!]
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  29. Kevin J. Lansing, 2000. "Learning about a shift in trend output: implications for monetary policy and inflation," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
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  32. Timothy Cogley & Thomas Sargent, . "Evolving Post-World War II U.S. Inflation Dynamics," Working Papers 2132872, Department of Economics, W. P. Carey School of Business, Arizona State University. [Downloadable!]
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  33. Svensson, Lars E. O. & Woodford, Michael, 2003. "Indicator variables for optimal policy," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 691-720, April. [Downloadable!] (restricted)
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  34. Lawrence J. Christiano & Terry J. Fitzgerald, 1999. "The Band pass filter," Working Paper 9906, Federal Reserve Bank of Cleveland. [Downloadable!]
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  36. Athanasios Orphanides, 2002. "Monetary-Policy Rules and the Great Inflation," American Economic Review, American Economic Association, vol. 92(2), pages 115-120, May. [Downloadable!]
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Full references

Cited by:
(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. Athanasios Orphanides & John C. Williams, 2006. "Inflation targeting under imperfect knowledge," Finance and Economics Discussion Series 2006-20, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  2. Livio Stracca, 2006. "A speed limit monetary policy rule for the euro area," Working Paper Series 600, European Central Bank. [Downloadable!]
    Other versions:
  3. Athanasios Orphanides & John C. Williams, 2007. "Robust monetary policy with imperfect knowledge," Working Paper Series 2007-08, Federal Reserve Bank of San Francisco. [Downloadable!]
    Other versions:
  4. Athanasios Orphanides & John C. Williams, 2005. "Monetary policy with imperfect knowledge," Finance and Economics Discussion Series 2005-51, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  5. Richard A. Ashley & Randall J. Verbrugge., 2006. "Mis-Specification in Phillips Curve Regressions: Quantifying Frequency Dependence in This Relationship While Allowing for Feedback," Working Papers e06-11, Virginia Polytechnic Institute and State University, Department of Economics. [Downloadable!]
  6. Richard A. Ashley. & Randall J. Verbrugge., 2006. "Mis-Specification and Frequency Dependence in a New Keynesian Phillips Curve," Working Papers e06-12, Virginia Polytechnic Institute and State University, Department of Economics. [Downloadable!]
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