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Model Uncertainty, Robust Policies, And The Value Of Commitment

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  • Kasa, Kenneth

Abstract

Using results from the literature on H∞ control, this paper incorporates model uncertainty into a frequency-domain approach to stabilization policy. The derived policies guarantee a minimum performance level even in the worst of (a bounded set of) circumstances. Robust H∞ policies are shown to be more “activist” than H2 policies in the sense that their impulse responses are larger. Robust policies also tend to be more autocorrelated. Consequently, the premium associated with being able to commit is greater under model uncertainty. Without commitment, the policymaker is not able to (credibly) smooth his response to the degree that he would like. A contribution of this paper is its analysis of robust control in a model featuring a forward-looking state transition equation, which arises from the fact that the private sector bases its decisions on expectations of future government policy. Existing applications of H∞ control in economics follow the engineering literature, and only consider backward-looking state transition equations.

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  • Kasa, Kenneth, 2002. "Model Uncertainty, Robust Policies, And The Value Of Commitment," Macroeconomic Dynamics, Cambridge University Press, vol. 6(1), pages 145-166, February.
  • Handle: RePEc:cup:macdyn:v:6:y:2002:i:01:p:145-166_02
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    References listed on IDEAS

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    Cited by:

    1. Oreste Tristani, 2009. "Model Misspecification, the Equilibrium Natural Interest Rate, and the Equity Premium," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1453-1479, October.
    2. Martin Ellison & Thomas J. Sargent, 2012. "A Defense Of The Fomc," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(4), pages 1047-1065, November.
    3. Marc P. Giannoni, 2007. "Robust optimal monetary policy in a forward-looking model with parameter and shock uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 179-213.
    4. Dennis, Richard, 2014. "Imperfect credibility and robust monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 44(C), pages 218-234.
    5. 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.
    6. Kasa, Kenneth, 2001. "A robust Hansen-Sargent prediction formula," Economics Letters, Elsevier, vol. 71(1), pages 43-48, April.
    7. Brock, William A. & Durlauf, Steven N., 2005. "Local robustness analysis: Theory and application," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 2067-2092, November.
    8. Hansen, Lars Peter & Mayer, Ricardo & Sargent, Thomas, 2010. "Robust hidden Markov LQG problems," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 1951-1966, October.
    9. Luo, Yulei & Nie, Jun & Young, Eric R., 2014. "Model uncertainty and intertemporal tax smoothing," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 289-314.
    10. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 581-604, April.
    11. 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(1), pages 111-144, February.
    12. Michael Paetz, 2007. "Robust Control and Persistence in the New Keynesian Economy," Quantitative Macroeconomics Working Papers 20711, Hamburg University, Department of Economics.
    13. Nikos Tsotsolas & Spiros Alexopoulos, 2019. "Towards a holistic strategic framework for applying robust facilitated approaches in political decision making," Operational Research, Springer, vol. 19(2), pages 501-541, June.
    14. Marc Giannoni, 2006. "Robust Optimal Policy in a Forward-Looking Model with Parameter and Shock Uncertainty," NBER Working Papers 11942, National Bureau of Economic Research, Inc.

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