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Monetary Policy under Model and Data-Parameter Uncertainty


  • Gino Cateau


Policy-makers in the United States over the past 15 to 20 years seem to have been cautious in setting policy: empirical estimates of monetary policy rules such as Taylor's (1993) rule are much less aggressive than those derived from optimizing models. The author analyzes the effect of an aversion to model and data-parameter uncertainty on monetary policy. Model uncertainty arises because a central bank finds three competing models of the economy to be plausible. Data uncertainty arises because real-time data are noisy estimates of the true data. The central bank explicitly models the measurement-error processes for both inflation and the output gap, and it acknowledges that it may not know the parameters of those processes precisely (which leads to data-parameter uncertainty). The central bank chooses policy according to a Taylor rule in a framework that allows an aversion to the distinct risk associated with multiple models and dataparameter configurations. The author finds that, if the central bank cares strongly enough about stabilizing the output gap, this aversion generates significant declines in the coefficients of the Taylor rule, even if the bank's loss function assigns little weight to reducing interest rate variability. He also finds that an aversion to model and data-parameter uncertainty can yield an optimal Taylor rule that matches the empirical Taylor rule. Under some conditions, a small degree of aversion is enough to match the historical rule.

Suggested Citation

  • Gino Cateau, 2005. "Monetary Policy under Model and Data-Parameter Uncertainty," Staff Working Papers 05-6, Bank of Canada.
  • Handle: RePEc:bca:bocawp:05-6

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    Cited by:

    1. Cateau, Gino, 2007. "Monetary policy under model and data-parameter uncertainty," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2083-2101, October.
    2. Gino Cateau, 2006. "Guarding Against Large Policy Errors under Model Uncertainty," Staff Working Papers 06-13, Bank of Canada.
    3. Melecky, Ales & Melecky, Martin, 2010. "From inflation to exchange rate targeting: Estimating the stabilization effects for a small open economy," Economic Systems, Elsevier, vol. 34(4), pages 450-468, December.

    More about this item


    Uncertainty and monetary policy;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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