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Caution in macroeconomic policy: uncertainty and the relative intensity of policy

  • Mercado, P. Ruben
  • Kendrick, David A.

Two lines of literature show that increased uncertainty results in decreased vigor of the control variable in the first time period. The first line uses static models, the second dynamic. Here, the dynamic line is extended from one-state, one-control models to ones with two control variables. We confirm the Johansen result from the static line that, in this case, one control is used less intensely and the other more intensely when current uncertainty is increased. We then extend this result to models with zero weights on the controls, giving a linear complementarity outcome. Analyses from both lines of the literature effectively involve single-period results, since even the dynamic line has focused on the effects of current uncertainty. Here we follow a suggestion from Craine to extend the results to a multiperiod framework. Using the Riccati equations, we study the effects of increased uncertainty in a future time period on the use of controls in the first time period. We find, contrary to the single-period results, that the outcomes reveal that both control variables (or at least one, depending of the relative magnitude of first-period control parameter weighted variances) are used more, rather than less, intensely.

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File URL: http://www.sciencedirect.com/science/article/B6V84-405JSFV-7/2/9be7975e2a0dd444f44c951d71696490
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Article provided by Elsevier in its journal Economics Letters.

Volume (Year): 68 (2000)
Issue (Month): 1 (July)
Pages: 37-41

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Handle: RePEc:eee:ecolet:v:68:y:2000:i:1:p:37-41
Contact details of provider: Web page: http://www.elsevier.com/locate/ecolet

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  1. Amman, Hans M & Kendrick, David A, 1999. "Should Macroeconomic Policy Makers Consider Parameter Covariances?," Computational Economics, Society for Computational Economics, vol. 14(3), pages 263-67, December.
  2. Shupp, Franklin R., 1976. "Uncertainty and optimal stabilization policy," Journal of Public Economics, Elsevier, vol. 6(3), pages 243-253, October.
  3. Hans M. Amman & David A. Kendrick, 1996. "The DUALI/DUALPC Software for Optimal Control Models: Introduction," CARE Working Papers 9602, The University of Texas at Austin, Center for Applied Research in Economics.
  4. Turnovsky, Stephen J, 1975. "Optimal Choice of Monetary Instrument in a Linear Economic Model with Stochastic Coefficients," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 7(1), pages 51-80, February.
  5. 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.
  6. Franklin R. Shupp, 1976. "Uncertainty and Optimal Policy Intensity in Fiscal and Incomes Policies," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 5, number 2, pages 225-237 National Bureau of Economic Research, Inc.
  7. Pohjola, Matti T., 1981. "Uncertainty and the vigour of policy Some implications of quadratic preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 3(1), pages 299-305, November.
  8. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
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