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

Author Info

  • 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.

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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
Date of revision:
Handle: RePEc:boe:boeewp:0414
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Find related papers by 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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  1. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  2. Timothy Cogley & Riccardo Colacito & Thomas J. Sargent, 2005. "Benefits from U.S. monetary policy experimentation in the days of Samuelson and Solow and Lucas," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  3. Brock, William A. & Durlauf, Steven N. & West, Kenneth D., 2007. "Model uncertainty and policy evaluation: Some theory and empirics," Journal of Econometrics, Elsevier, vol. 136(2), pages 629-664, February.
  4. Svensson, Lars E O & Williams, Noah, 2007. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," CEPR Discussion Papers 6331, C.E.P.R. Discussion Papers.
  5. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
  6. George Kapetanios & Vincent Labhard & Simon Price, 2005. "Forecasting using Bayesian and information theoretic model averaging: an application to UK inflation," Bank of England working papers 268, Bank of England.
  7. Timothy Cogley & Riccardo Colacito & Lars Peter Hansen & Thomas J. Sargent, 2008. "Robustness and U.S. Monetary Policy Experimentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1599-1623, December.
  8. Levine, Paul & McAdam, Peter & Pearlman, Joseph G. & Pierse, Richard, 2008. "Risk Management in Action. Robust monetary policy rules under structured uncertainty," Working Paper Series 0870, European Central Bank.
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Cited by:

  1. Francesca Rondina, 2010. "The role of model uncertainty and learning in the U.S. postwar policy response to oil prices," Working Papers 478, Barcelona Graduate School of Economics.
  2. Vito Polito & Peter Spencer, . "UK Macroeconomic Volatility and the Welfare Costs of Inflation," Discussion Papers 11/21, Department of Economics, University of York.
  3. 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.
  4. Francesca Rondina, 2010. "Policy Evaluation and Uncertainty About the Effects of Oil Prices on Economic Activity," Working Papers 522, Barcelona Graduate School of Economics.
  5. Francesca Rondina, 2010. "The role of model uncertainty and learning in the U.S. postwar policy response to oil prices," UFAE and IAE Working Papers 834.10, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  6. Gradojevic, Nikola & Gençay, Ramazan, 2013. "Fuzzy logic, trading uncertainty and technical trading," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 578-586.
  7. Federico Ravenna, 2014. "How Central Banks Learn the True Model of the Economy," Cahiers de recherche 1409, CIRPEE.
  8. Ravenna, Federico, 2012. "Optimal monetary policy and model selection in a real-time learning environment," Economics Letters, Elsevier, vol. 114(3), pages 322-325.

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