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Elements of a Theory of Design Limits to Optimal Policy

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  • William A. Brock
  • Steven N. Durlauf

Abstract

This paper presents a framework for understanding the limits that exist in optimal policy design in dynamic contexts. We consider the design of policies in the context of dynamic linear models. Fundamental design limits exist for policy rules in such environments in the sense that any policy rule embodies tradeoffs between the magnitudes of different frequency-specific components of the variance. Hence policies that are effective in eliminating low frequency variance components of a state variable can only do so at the cost of exacerbating high frequency variance components, and vice versa. Examples of the implications of such tradeoffs are considered.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10495.

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Date of creation: May 2004
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Publication status: published as William A. Brock & Steven N. Durlauf, 2004. "Elements of a Theory of Design Limits to Optimal Policy," Manchester School, University of Manchester, vol. 72(s1), pages 1-18, 09.
Handle: RePEc:nbr:nberwo:10495

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  1. Alexei Onatski & James H. Stock, 2000. "Robust Monetary Policy Under Model Uncertainty in a Small Model of the U.S. Economy," NBER Working Papers 7490, National Bureau of Economic Research, Inc.
  2. Marcellino, Massimiliano & Salmon, Mark, 2002. "Robust Decision Theory And The Lucas Critique," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 6(01), pages 167-185, February.
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  4. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 6(01), pages 111-144, February.
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  6. Otrok, C. & Ravikumar, B. & Whiteman, C., 1998. "Habit Formation: A Resolution of the Equity Premium Puzzle?," Working Papers, University of Iowa, Department of Economics 98-04, University of Iowa, Department of Economics.
  7. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(3), pages 581-604, April.
  8. Otrok, Christopher, 2001. "Spectral Welfare Cost Functions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 345-67, May.
  9. Athanasios Orphanides & John C. Williams, 2002. "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 63-146.
  10. Lars Peter Hansen & Thomas J. Sargent, 2001. "Acknowledging Misspecification in Macroeconomic Theory," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 519-535, July.
  11. Christopher A. Sims, 2001. "Pitfalls of a Minimax Approach to Model Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 51-54, May.
  12. Brock,W.A. & Durlauf,S.N. & West,K.D., 2003. "Policy evaluation in uncertain economic environments," Working papers, Wisconsin Madison - Social Systems 15, Wisconsin Madison - Social Systems.
  13. Robert J. Tetlow & Peter von zur Muehlen, 2000. "Robust monetary policy with misspecified models: does model uncertainty always call for attenuated policy?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2000-28, Board of Governors of the Federal Reserve System (U.S.).
  14. Onatski, Alexei & Williams, Noah, 2002. "Modeling model uncertainty," Working Paper Series, European Central Bank 0169, European Central Bank.
  15. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  16. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
  17. repec:cup:macdyn:v:6:y:2002:i:1:p:167-85 is not listed on IDEAS
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Cited by:
  1. Travaglini, Guido, 2007. "The U.S. Dynamic Taylor Rule With Multiple Breaks, 1984-2001," MPRA Paper 3419, University Library of Munich, Germany, revised 15 Jun 2007.
  2. Xiangrong Yu, 2013. "Measurement Error and Policy Evaluation in the Frequency Domain," Working Papers 172013, Hong Kong Institute for Monetary Research.
  3. William A. Brock & Steven N. Durlauf & James M. Nason & Giacomo Rondina, 2007. "Simple versus optimal rules as guides to policy," Working Paper, Federal Reserve Bank of Atlanta 2007-07, Federal Reserve Bank of Atlanta.
  4. Brock, William A. & Durlauf, Steven N., 2005. "Local robustness analysis: Theory and application," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(11), pages 2067-2092, November.
  5. Beatrice Pataracchia, 2008. "Design Limits in Regime-Switching Cases," Department of Economics University of Siena, Department of Economics, University of Siena 529, Department of Economics, University of Siena.
  6. William Brock & Steven Durlauf & Kenneth West, 2005. "Model uncertainty and policy evaluation: some theory and empirics," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  7. Brock, William A. & Durlauf, Steven N. & Rondina, Giacomo, 2013. "Design limits and dynamic policy analysis," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(12), pages 2710-2728.
  8. Beatrice Pataracchia, 2008. "The Spectral Representation of Markov-Switching Arma Models," Department of Economics University of Siena, Department of Economics, University of Siena 528, Department of Economics, University of Siena.
  9. Brock,W.A. & Durlauf,S.N., 2004. "Macroeconomics and model uncertainty," Working papers, Wisconsin Madison - Social Systems 20, Wisconsin Madison - Social Systems.
  10. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion, Robust Control and Asset Holdings," Working Papers, University of Crete, Department of Economics 0402, University of Crete, Department of Economics.
  11. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion and Robust Portfolio Choices," Working Papers, University of Crete, Department of Economics 0408, University of Crete, Department of Economics.

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