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A Bayesian approach to optimal monetary policy with parameter and model uncertainty

  • Cogley, Timothy
  • De Paoli, Bianca
  • Matthes, Christian
  • Nikolov, Kalin
  • Yates, Tony

This paper undertakes a Bayesian analysis of optimal monetary policy for the U.K. We estimate a suite of monetary-policy models that include both forward- and backward-looking representations as well as large- and small-scale models. We find an optimal simple Taylor-type rule that accounts for both model and parameter uncertainty. For the most part, backward-looking models are highly fault tolerant with respect to policies optimized for forward-looking representations, while forward-looking models have low fault tolerance with respect to policies optimized for backward-looking representations. In addition, backward-looking models often have lower posterior probabilities than forward-looking models. Bayesian policies therefore have characteristics suitable for inflation and output stabilization in forward-looking models.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 12 ()
Pages: 2186-2212

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:12:p:2186-2212
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Kapetanios, G. & Labhard, V. & Price, S., 2007. "Forecasting using Bayesian and information theoretic model averaging: an application to UK inflation," Working Papers 07/15, Department of Economics, City University London.
  2. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
  3. Brock,W.A. & Durlauf,S.N. & West,K.D., 2004. "Model uncertainty and policy evaluation : some theory and empirics," Working papers 19, Wisconsin Madison - Social Systems.
  4. Svensson, Lars E O & Williams, Noah, 2007. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," CEPR Discussion Papers 6331, C.E.P.R. Discussion Papers.
  5. Levine, Paul & McAdam, Peter & Pearlman, Joseph G. & Pierse, Richard, 2008. "Risk Management in Action. Robust monetary policy rules under structured uncertainty," Working Paper Series 0870, European Central Bank.
  6. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  7. 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.
  8. Timothy Cogley & Riccardo Colacito & Lars Peter Hansen & Thomas J. Sargent, 2008. "Robustness and U.S. Monetary Policy Experimentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1599-1623, December.
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