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Welfare-maximizing monetary policy under parameter uncertainty

  • Rochelle M. Edge

    (Board of Governors of the Federal Reserve System, Washington, DC, USA)

  • Thomas Laubach

    (Goethe University Frankfurt, Germany)

  • John C. Williams

    (Federal Reserve Bank of San Francisco, CA, USA)

This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the US economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies uncertainty about the model's dynamics, utility-based welfare criterion and the 'natural' rates of output and interest that would prevail absent nominal rigidities. We estimate the degree of uncertainty regarding natural rates due to parameter uncertainty. We find that optimal Taylor rules under parameter uncertainty respond less to the output gap and more to price inflation than would be optimal absent parameter uncertainty. We also show that policy rules that focus solely on stabilizing wages and prices yield welfare outcomes very close to the first-best. Copyright © 2009 John Wiley & Sons, Ltd.

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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 25 (2010)
Issue (Month): 1 ()
Pages: 129-143

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Handle: RePEc:jae:japmet:v:25:y:2010:i:1:p:129-143
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