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Monetary Policy with Model Uncertainty: Distribution Forecast Targeting

  • Lars Svensson
  • Noah Williams

We examine optimal and other monetary policies in a linear-quadratic setup with a relatively general form of model uncertainty, so-called Markov jump-linear-quadratic systems extended to include forward-looking variables. The form of model uncertainty our framework encompasses includes: simple i.i.d. model deviations; serially correlated model deviations; estimable regime-switching models; more complex structural uncertainty about very different models, for instance, backward- and forward-looking models; time-varying central-bank judgment about the state of model uncertainty; and so forth. We provide an algorithm for finding the optimal policy as well as solutions for arbitrary policy functions. This allows us to compute and plot consistent distribution forecasts---fan charts---of target variables and instruments. Our methods hence extend certainty equivalence and "mean forecast targeting" to more general certainty non-equivalence and "distribution forecast targeting."

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File URL: http://www.nber.org/papers/w11733.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11733.

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Date of creation: Nov 2005
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Handle: RePEc:nbr:nberwo:11733
Note: EFG IFM ME
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  1. Svensson, Lars E. O., 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Working Paper Series 91, Sveriges Riksbank (Central Bank of Sweden).
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  3. Andrew T. Levin & Alexei Onatski & John Williams & Noah M. Williams, 2006. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 229-312 National Bureau of Economic Research, Inc.
  4. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
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  13. Fabrizio Zampolli, 2004. "Optimal monetary policy in a regime-switching economy," Computing in Economics and Finance 2004 166, Society for Computational Economics.
  14. Svensson, Lars E. O., 2005. "Monetary policy with judgment: forecast targeting," Working Paper Series 0476, European Central Bank.
  15. Lars E.O. Svensson & Robert J. Tetlow, 2005. "Optimal Policy Projections," International Journal of Central Banking, International Journal of Central Banking, vol. 1(3), December.
  16. Fabrizio Zampolli, 2006. "Optimal monetary policy in a regime-switching economy: the response to abrupt shifts in exchange rate dynamics," Bank of England working papers 297, Bank of England.
  17. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92 National Bureau of Economic Research, Inc.
  18. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2007. "Understanding the New-Keynesian Model when Monetary Policy Switches Regimes," NBER Working Papers 12965, National Bureau of Economic Research, Inc.
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  30. 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.).
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