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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 not only uncertainty about the dynamics of the economy. It also implies uncertainty about the model's utility-based welfare criterion and about the economy's natural rate measures of interest and output. We analyze the characteristics and performance of alternative monetary policy rules given the estimated uncertainty regarding parameter estimates. We find that the natural rates of interest and output are imprecisely estimated. We then show that, relative to the case of known parameters, optimal policy under parameter uncertainty responds less to natural-rate terms and more to other variables, such as price and wage inflation and measures of tightness or slack that do not depend on natural rates.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2007-56.

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Date of creation: 2007
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Handle: RePEc:fip:fedgfe:2007-56

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Keywords: Monetary policy ; Uncertainty;

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References

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Citations

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Cited by:
  1. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2007. "Welfare-maximizing monetary policy under parameter uncertainty," Proceedings, Federal Reserve Bank of San Francisco.
  2. André P. Calmon & Thomas Vallée & João B. R. Do Val, 2009. "Monetary policy as a source of uncertainty," Working Papers hal-00422454, HAL.
  3. Paez-Farrell, Juan, 2014. "Resuscitating the ad hoc loss function for monetary policy analysis," Economics Letters, Elsevier, vol. 123(3), pages 313-317.
  4. Avouyi-Dovi, S. & Sahuc, J-G., 2011. "On the Welfare Costs of Misspecified Monetary Policy Objectives," Working papers 320, Banque de France.
  5. 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.
  6. John C. Williams, 2013. "A defense of moderation in monetary policy," Working Paper Series 2013-15, Federal Reserve Bank of San Francisco.
  7. Carl Walsh, 2007. "Inflation Targeting and the Role of Real Objectives," Research and Policy Notes 2007/02, Czech National Bank, Research Department.
  8. 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.

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