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

Listed author(s):
  • 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)

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.

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File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2011/wp414.pdf
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Paper provided by Bank of England in its series Bank of England working papers with number 414.

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Length: 74 pages
Date of creation: 02 Mar 2011
Handle: RePEc:boe:boeewp:0414
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