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Welfare‐maximizing monetary policy under parameter uncertainty

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  • Rochelle M. Edge
  • Thomas Laubach
  • John C. Williams

Abstract

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.

Suggested Citation

  • Rochelle M. Edge & Thomas Laubach & John C. Williams, 2010. "Welfare‐maximizing monetary policy under parameter uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 129-143, January.
    • Handle: RePEc:wly:japmet:v:25:y:2010:i:1:p:129-143
    DOI: 10.1002/jae.1136
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    Cited by:

    1. Grzegorz Wesołowski, 2021. "Monetary Policy and House Price Volatility," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 13(4), pages 359-379, December.
    2. Tillmann Peter, 2021. "Robust Monetary Policy Under Uncertainty About the Lower Bound," The B.E. Journal of Macroeconomics, De Gruyter, vol. 21(1), pages 309-321, January.
    3. Pei-Tha Gan, 2014. "The Optimal Economic Uncertainty Index: A Grid Search Application," Computational Economics, Springer;Society for Computational Economics, vol. 43(2), pages 159-182, February.
    4. Naoto Soma, 2021. "Parameter Uncertainty and Effective Lower Bound Risk," IMES Discussion Paper Series 21-E-11, Institute for Monetary and Economic Studies, Bank of Japan.
    5. Sala, Luca & Söderström, Ulf & Trigari, Antonella, 2008. "Monetary policy under uncertainty in an estimated model with labor market frictions," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 983-1006, July.
    6. Özer Karagedikli & Troy Matheson & Christie Smith & Shaun P. Vahey, 2010. "RBCs AND DSGEs: THE COMPUTATIONAL APPROACH TO BUSINESS CYCLE THEORY AND EVIDENCE," Journal of Economic Surveys, Wiley Blackwell, vol. 24(1), pages 113-136, February.
    7. Williams, John C., 2013. "A defense of moderation in monetary policy," Journal of Macroeconomics, Elsevier, vol. 38(PB), pages 137-150.
    8. Anthony M. Diercks, 2015. "The Equity Premium, Long-Run Risk, & Optimal Monetary Policy," Finance and Economics Discussion Series 2015-87, Board of Governors of the Federal Reserve System (U.S.).
    9. Gelain, Paolo & Manganelli, Simone, 2020. "Monetary policy with judgment," Working Paper Series 2404, European Central Bank.
    10. Yibai Yang, 2018. "On the Optimality of IPR Protection with Blocking Patents," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 27, pages 205-230, January.
    11. Górajski, Mariusz & Kuchta, Zbigniew, 2023. "Coordination and non-coordination risks of monetary and macroprudential authorities: A robust welfare analysis," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).
    12. Anthony Diercks, 2016. "The Equity Premium, Long-Run Risk, and Optimal Monetary Policy," 2016 Meeting Papers 207, Society for Economic Dynamics.
    13. Taylor, John B. & Williams, John C., 2010. "Simple and Robust Rules for Monetary Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 15, pages 829-859, Elsevier.
    14. Wieland, Volker & Cwik, Tobias & Müller, Gernot J. & Schmidt, Sebastian & Wolters, Maik, 2012. "A new comparative approach to macroeconomic modeling and policy analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 83(3), pages 523-541.
    15. Avouyi-Dovi, Sanvi & Sahuc, Jean-Guillaume, 2011. "On the welfare costs of misspecified monetary policy objectives," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 151-161, June.
    16. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2010. "Welfare‐maximizing monetary policy under parameter uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 129-143, January.
    17. Paez-Farrell, Juan, 2014. "Resuscitating the ad hoc loss function for monetary policy analysis," Economics Letters, Elsevier, vol. 123(3), pages 313-317.
    18. André P. Calmon & Thomas Vallée & João B. R. Do Val, 2009. "Monetary policy as a source of uncertainty," Working Papers hal-00422454, HAL.

    More about this item

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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