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Won’t Get Fooled Again – Or Will We? Monetary Policy, Model Uncertainty, and ‘Policy Model Complacency’

Author

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  • Mark Setterfield

    (Department of Economics, New School for Social Research)

Abstract

The question addressed in this paper is: can monetary policy succeed in stabilizing the economy even when the policy model on which it is predicated is mis-specified? Using variants of the 3-equation New Consensus Macroeconomics model, it is shown that this question can be answered in the affirmative. The purpose of the paper is not to encourage indifference towards model uncertainty, however, but rather to warn against the perils of “policy model complacency”. This arises if the success of policy is misinterpreted as successful understanding of the workings of the economy, which makes the policy maker vulnerable to surprises: events with systematic origins in the “true” model of the economy that are not anticipated by the (mis-specified) policy model. To safeguard against this problem, policy makers should always entertain eclectic views of the workings of the economy – a task that is easily accomplished by paying more attention to “outside the mainstream” macroeconomic thinking that frequently makes predictions that are at odds with those of the dominant policy model.

Suggested Citation

  • Mark Setterfield, 2015. "Won’t Get Fooled Again – Or Will We? Monetary Policy, Model Uncertainty, and ‘Policy Model Complacency’," Working Papers 1516, New School for Social Research, Department of Economics, revised Jan 2016.
    • Handle: RePEc:new:wpaper:1516
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    File URL: https://repec.economicpolicyresearch.org/econ/2015/NSSR_WP_162015.pdf
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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