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Confidence in Monetary Policy

  • Yakov Ben-Haim
  • Maria Demertzis

In situations of relative calm and certainty, policy makers have confidence in the mechanisms at work and feel capable of attaining precise and ambitious results. As the environment becomes less and less certain, policy makers are confronted with the fact that there is a trade-off between the quality of a certain outcome and the confidence (robustness) with which it can be attained. Added to that, in the presence of Knightian uncertainty, confidence itself can no longer be represented in probabilistic terms (because probabilities are unknown). We adopt the technique of Info-Gap Robust Satisficing to first define confidence under Knightian uncertainty, and second quantify the trade-off between quality and robustness explicitly.We apply this to a standard monetary policy example and provide Central Banks with a framework to rank policies in a way that will allow them to pick the one that either maximizes confidence given an acceptable level of performance, or alternatively, optimizes performance for a given level of confidence.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 192.

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Date of creation: Dec 2008
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Handle: RePEc:dnb:dnbwpp:192
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Web page: http://www.dnb.nl/en/

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  1. Maria Demertzis & Nicola Viegi, 2007. "Inflation Targeting - a Framework for Communication," DNB Working Papers 149, Netherlands Central Bank, Research Department.
  2. Christopher A. Sims, 2001. "Pitfalls of a Minimax Approach to Model Uncertainty," American Economic Review, American Economic Association, vol. 91(2), pages 51-54, May.
  3. repec:cup:cbooks:9780521118361 is not listed on IDEAS
  4. John Conlisk, 1996. "Why Bounded Rationality?," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 669-700, June.
  5. Antulio N. Bomfim & Glenn D. Rudebusch, 1998. "Opportunistic and deliberate disinflation under imperfect credibility," Finance and Economics Discussion Series 1998-01, Board of Governors of the Federal Reserve System (U.S.).
  6. William Poole, 2004. "Best guesses and surprises," Speech 22, Federal Reserve Bank of St. Louis.
  7. Armen A. Alchian, 1950. "Uncertainty, Evolution, and Economic Theory," Journal of Political Economy, University of Chicago Press, vol. 58, pages 211.
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