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Monetary Policy with Model Uncertainty: Distribution Forecast Targeting

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Author Info
Lars Svensson
Noah Williams

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Abstract

We examine optimal and other monetary policies in a linear-quadratic setup with a relatively general form of model uncertainty, so-called Markov jump-linear-quadratic systems extended to include forward-looking variables. The form of model uncertainty our framework encompasses includes: simple i.i.d. model deviations; serially correlated model deviations; estimable regime-switching models; more complex structural uncertainty about very different models, for instance, backward- and forward-looking models; time-varying central-bank judgment about the state of model uncertainty; and so forth. We provide an algorithm for finding the optimal policy as well as solutions for arbitrary policy functions. This allows us to compute and plot consistent distribution forecasts---fan charts---of target variables and instruments. Our methods hence extend certainty equivalence and "mean forecast targeting" to more general certainty non-equivalence and "distribution forecast targeting."

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11733.

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Date of creation: Nov 2005
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Handle: RePEc:nbr:nberwo:11733

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Find related papers by JEL classification:
E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
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

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  1. Timothy Cogley & Riccardo Colacito & Thomas J. Sargent, 2007. "Benefits from U.S. Monetary Policy Experimentation in the Days of Samuelson and Solow and Lucas," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 67-99, 02. [Downloadable!] (restricted)
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  2. Lars E O Svensson, 2005. "Monetary Policy with Judgment: Forecast Targeting," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May. [Downloadable!]
    Other versions:
  3. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April. [Downloadable!] (restricted)
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  4. Evan W. Anderson & Lars Peter Hansen & Ellen R. McGrattan & Thomas J. Sargent, 1995. "On the mechanics of forming and estimating dynamic linear economies," Staff Report 198, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  7. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary policy under uncertainty in micro-founded macroeconometric models," Working Papers in Applied Economic Theory 2005-15, Federal Reserve Bank of San Francisco. [Downloadable!]
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  8. 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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  9. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March. [Downloadable!] (restricted)
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  14. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March. [Downloadable!]
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  16. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination In Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc. [Downloadable!]
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  19. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May. [Downloadable!]
  20. Lars E.O. Svensson & Noah M. Williams, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," NBER Working Papers 13414, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan Standard," Working Papers 88, Princeton University, Department of Economics, Center for Economic Policy Studies.. [Downloadable!]
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  22. Chow, Gregory C, 1973. "Effect of Uncertainty on Optimal Control Policies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 14(3), pages 632-45, October. [Downloadable!] (restricted)
  23. Svensson, Lars, 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Seminar Papers 673, Stockholm University, Institute for International Economic Studies. [Downloadable!]
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  24. Svensson, Lars E O & Woodford, Michael, 2004. "Implementing Optimal Policy Through Inflation-Forecast Targeting," CEPR Discussion Papers 4229, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  25. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2007. "Understanding the New Keynesian model when monetary policy switches regimes," Working Paper 2007-12, Federal Reserve Bank of Atlanta. [Downloadable!]
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  26. Zampolli, Fabrizio, 2006. "Optimal monetary policy in a regime-switching economy: The response to abrupt shifts in exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1527-1567. [Downloadable!] (restricted)
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  29. Alexei Onatski & Noah Williams, 2003. "Modeling Model Uncertainty," NBER Working Papers 9566, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  30. do Val, Joao B. R. & Basar, Tamer, 1999. "Receding horizon control of jump linear systems and a macroeconomic policy problem1," Journal of Economic Dynamics and Control, Elsevier, vol. 23(8), pages 1099-1131, August. [Downloadable!] (restricted)
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