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Modeling model uncertainty

  • Onatski, Alexei
  • Williams, Noah

Recently there has been much interest in studying monetary policy under model uncertainty. We develop methods to analyze different sources of uncertainty in one coherent structure useful for policy decisions. We show how to estimate the size of the uncertainty based on time series data, and incorporate this uncertainty in policy optimization. We propose two different approaches to modeling model uncertainty. The first is model error modeling, which imposes additional structure on the errors of an estimated model, and builds a statistical description of the uncertainty around a model. The second is set membership identification, which uses a deterministic approach to find a set of models consistent with data and prior assumptions. The center of this set becomes a benchmark model, and the radius measures model uncertainty. Using both approaches, we compute the robust monetary policy under different model uncertainty specifications in a small model of the US economy. JEL Classification: E52, C32, D81

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Paper provided by European Central Bank in its series Working Paper Series with number 0169.

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Date of creation: Aug 2002
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Handle: RePEc:ecb:ecbwps:20020169
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  1. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  2. John Rust, 1997. "Using Randomization to Break the Curse of Dimensionality," Econometrica, Econometric Society, vol. 65(3), pages 487-516, May.
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  10. Alan S. Blinder, 1997. "Distinguished Lecture on Economics in Government: What Central Bankers Could Learn from Academics--And Vice Versa," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 3-19, Spring.
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  12. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
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  16. Alexei Onatski & James H. Stock, 1999. "Robust monetary policy under model uncertainty in a small model of the U.S. economy," Proceedings, Federal Reserve Bank of San Francisco.
  17. Giordani, Paolo & Söderlind, Paul, 2002. "Solution of Macromodels with Hansen-Sargent Robust Policies: Some Extensions," SSE/EFI Working Paper Series in Economics and Finance 499, Stockholm School of Economics, revised 15 May 2003.
  18. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  19. Eric T. Swanson, 2000. "On signal extraction and non-certainty-equivalence in optimal monetary policy rules," Finance and Economics Discussion Series 2000-32, Board of Governors of the Federal Reserve System (U.S.).
  20. J. Rust & J. F. Traub & H. Wozniakowski, 2002. "Is There a Curse of Dimensionality for Contraction Fixed Points in the Worst Case?," Econometrica, Econometric Society, vol. 70(1), pages 285-329, January.
  21. 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.
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