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Robust expectations and uncertain models – A robust control approach with application to the New Keynesian economy

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Author Info
Juha Kilponen (Bank of Finland)

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Abstract

This paper extends Svensson and Woodford’s (2003) partial information framework by allowing the private agents to achieve robustness against incomplete information about the structure of the economy by distorting their expectations in a particular direction. It shows how a linear rational expectations equilibrium under concern for robustness can be solved by exploiting the recursive structure of the problem and appropriately modifying the Bellman equations in their framework. The standard Kalman filter is then used for information updating under imperfect measurement of the state variables. The standard New Keynesian model is used for illustrating how concern for modelling errors interacts with imperfect information. Agents achieve robustness by simultaneously over-estimating the persistence of exogenous shocks, but under-estimating the policy response to the output gap. This under- estimation, combined with imperfect measurement, leads to larger and more persistent responses of private consumption to government expenditure shocks under robust expectations.

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Paper provided by EconWPA in its series GE, Growth, Math methods with number 0404004.

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Date of creation: 26 Apr 2004
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Handle: RePEc:wpa:wuwpge:0404004

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Related research
Keywords: expectations; robust control; model uncertainty; monetary policy; imperfect information;

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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References listed on IDEAS
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. Giordani, Paolo & Söderlind, Paul, 2002. "Solution of Macromodels with Hansen-Sargent Robust Policies: Some Extensions," Working Paper Series in Economics and Finance 499, Stockholm School of Economics, revised 15 May 2003. [Downloadable!]
    Other versions:
  2. 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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  3. Svensson, Lars E. O. & Woodford, Michael, 2001. "Indicator Variables for Optimal Policy under Asymmetric Information," Seminar Papers 689, Stockholm University, Institute for International Economic Studies. [Downloadable!]
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  4. Pearlman, Joseph & Currie, David & Levine, Paul, 1986. "Rational expectations models with partial information," Economic Modelling, Elsevier, vol. 3(2), pages 90-105, April. [Downloadable!] (restricted)
  5. Lars Peter Hansen & Thomas J. Sargent, 1980. "Linear rational expectations models for dynamically interrelated variables," Working Papers 135, Federal Reserve Bank of Minneapolis. [Downloadable!]
  6. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
    Other versions:
  7. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  8. Miller, Marcus & Salmon, Mark, 1985. "Dynamic Games and the Time Inconsistency of Optimal Policy in Open Economies," Economic Journal, Royal Economic Society, vol. 95(380a), pages 124-37, Supplemen. [Downloadable!] (restricted)
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  9. Hansen, Lars Peter & Sargent, Thomas J. & Wang, Neng E., 2002. "Robust Permanent Income And Pricing With Filtering," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 40-84, February. [Downloadable!]
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  12. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 911-949, June. [Downloadable!] (restricted)
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  13. Kilponen , Juha, 2003. "A positive theory of monetary policy and robust control," Research Discussion Papers 18/2003, Bank of Finland. [Downloadable!]
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  14. Kenneth Kasa, 2000. "A robust Hansen-Sargent prediction formula," Working Papers in Applied Economic Theory 2000-11, Federal Reserve Bank of San Francisco.
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  15. Gerali, Andrea & Lippi, Francesco, 2003. "Optimal Control and Filtering in Linear Forward-looking Economies: A Toolkit," CEPR Discussion Papers 3706, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  16. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  17. Lars Peter Hansen & Thomas J. Sargent & Thomas D. Tallarini Jr., 1997. "Robust Permanent Income and Pricing," Levine's Working Paper Archive 596, David K. Levine. [Downloadable!]
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  18. Pearlman, Joseph G., 1992. "Reputational and nonreputational policies under partial information," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 339-357, April. [Downloadable!] (restricted)
  19. Currie, David & Levine, Paul L, 1986. "Credibility and Time Inconsistency in a Stochastic World," CEPR Discussion Papers 94, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  22. 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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  23. repec:cup:macdyn:v:6:y:2002:i:1:p:40-84 is not listed on IDEAS
  24. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 111-144, February. [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. Kilponen, Juha & Leitemo, Kai, 2006. "Robustness in monetary policymaking: a case for the Friedman rule," Research Discussion Papers 4/2006, Bank of Finland. [Downloadable!]
  2. Michael Funke & Michael Paetz, 2007. "Environmental Policy Under Model Uncertainty: A Robust Optimal Control Approach," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  3. Michael Paetz, 2007. "Robust Control and Persistence in the New Keynesian Economy," Quantitative Macroeconomics Working Papers 20711, Hamburg University, Department of Economics. [Downloadable!]
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