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A Bayesian approach to optimal monetary policy with parameter and model uncertainty

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  • Cogley, Timothy

    () (New York University)

  • de Paoli, Bianca

    () (Bank of England)

  • Matthes, Christian

    () (Universitat Pompeu Fabra)

  • Nikolov, Kalin

    () (European Central Bank)

  • Yates, Tony

    () (Bank of England)

Abstract

This paper undertakes a Bayesian analysis of optimal monetary policy for the United Kingdom. We estimate a suite of monetary policy models that include both forward and backward-looking representations as well as large and small-scale models. We find an optimal simple Taylor-type rule that accounts for both model and parameter uncertainty. For the most part, backward-looking models are highly fault tolerant with respect to policies optimised for forward-looking representations, while forward-looking models have low fault tolerance with respect to policies optimised for backward-looking representations. In addition, backward-looking models often have lower posterior probabilities than forward-looking models. Bayesian policies therefore have characteristics suitable for inflation and output stabilisation in forward-looking models.

Suggested Citation

  • Cogley, Timothy & de Paoli, Bianca & Matthes, Christian & Nikolov, Kalin & Yates, Tony, 2011. "A Bayesian approach to optimal monetary policy with parameter and model uncertainty," Bank of England working papers 414, Bank of England.
  • Handle: RePEc:boe:boeewp:0414
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    References listed on IDEAS

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    Cited by:

    1. William A. Brock & Steven N. Durlauf, 2015. "On Sturdy Policy Evaluation," The Journal of Legal Studies, University of Chicago Press, vol. 44(S2), pages 447-473.
    2. Rondina, Francesca, 2012. "The role of model uncertainty and learning in the US postwar policy response to oil prices," Journal of Economic Dynamics and Control, Elsevier, vol. 36(7), pages 1009-1041.
    3. Alexander Kriwoluzky & Christian A. Stoltenberg, 2016. "Nested Models and Model Uncertainty," Scandinavian Journal of Economics, Wiley Blackwell, vol. 118(2), pages 324-353, April.
    4. Ravenna, Federico, 2012. "Optimal monetary policy and model selection in a real-time learning environment," Economics Letters, Elsevier, vol. 114(3), pages 322-325.
    5. Francesca Rondina, 2010. "Policy evaluation and uncertainty about the effects of oil prices on economic activity," UFAE and IAE Working Papers 855.10, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    6. Francesca Rondina, 2017. "Model Uncertainty and the Direction of Fit of the Postwar U.S. Phillips Curve(s)," Working Papers 1702E, University of Ottawa, Department of Economics.
    7. Sheen, Jeffrey & Wang, Ben Zhe, 2016. "Animal spirits and optimal monetary policy design in the presence of labour market frictions," Economic Modelling, Elsevier, vol. 52(PB), pages 898-912.
    8. Ekaterina Pirozhkova, 2017. "Financial frictions and robust monetary policy in the models of New Keynesian framework," BCAM Working Papers 1701, Birkbeck Centre for Applied Macroeconomics.
    9. Anna Almosova, 2016. "Labor Market Frictions and Monetary Policy Design," SFB 649 Discussion Papers SFB649DP2016-054, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    10. Anderson, Evan W. & Brock, William & Sanstad, Alan H., 2016. "Robust Consumption and Energy Decisions," 2017 Allied Social Science Association (ASSA) Annual Meeting, January 6-8, 2017, Chicago, Illinois 250117, Agricultural and Applied Economics Association.
    11. Vito Polito & Peter Spencer, "undated". "UK Macroeconomic Volatility and the Welfare Costs of Inflation," Discussion Papers 11/21, Department of Economics, University of York.
    12. Gradojevic, Nikola & Gençay, Ramazan, 2013. "Fuzzy logic, trading uncertainty and technical trading," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 578-586.
    13. Jasmin Sin, 2016. "The Fiscal Multiplier in Small Open Economy; The Role of Liquidity Frictions," IMF Working Papers 16/138, International Monetary Fund.
    14. Federico Ravenna, 2014. "How Central Banks Learn the True Model of the Economy," Cahiers de recherche 1409, CIRPEE.

    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C54 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Quantitative Policy Modeling

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