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Welfare-Maximizing Monetary Policy Under Parameter Uncertainty

  • Rochelle M. Edge

    ()

  • Thomas Laubach

    ()

  • John C. Williams

    ()

This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the U.S. economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies uncertainty about the model’s dynamics, utility-based welfare criterion, and the “natural” rates of output and interest that would prevail absent nominal rigidities. We estimate the degree of uncertainty regarding natural rates due to parameter uncertainty. We find that optimal Taylor rules under parameter uncertainty respond less to the output gap and more to price inflation than would be optimal absent parameter uncertainty. We also show that policy rules that focus solely on stabilizing wages and prices yield welfare outcomes very close to the first-best.

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Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2008-16.

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Length: 45 pages
Date of creation: May 2008
Date of revision:
Handle: RePEc:een:camaaa:2008-16
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