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Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models

In: NBER Macroeconomics Annual 2005, Volume 20

  • Andrew T. Levin
  • Alexei Onatski
  • John Williams
  • Noah M. Williams

We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data, and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.

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This chapter was published in:
  • Mark Gertler & Kenneth Rogoff, 2006. "NBER Macroeconomics Annual 2005, Volume 20," NBER Books, National Bureau of Economic Research, Inc, number gert06-1.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 0070.
    Handle: RePEc:nbr:nberch:0070
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