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Robust Control Rules to Shield Against Indeterminacy

  • Nicoletta Batini
  • Paul Levine

We address robustness of inflation targeting rules in a New Keynesian model using two approaches. Firstly we use the Hansen-Sargent method, borrowed from the control theory literature, to design robust rules on the basis of the policymaker playing a game against malign nature. This welfare-based approach is intended to deal with worst case scenarios, but does not directly address stability robustness. Furthermore, in the case of forward-looking systems, it does not address indeterminacy robustness; thus a system may have good stability properties, but a small parameter change could lead to indeterminacy. Secondly, we address this latter issue by imposing a probability distribution on problematic parameters, and investigate both the probability of instability and the probability of indeterminacy of the robust rule. For comparison, we apply the same idea to inflation forecast based rules, which have the potential to perform well provided that there is enough interest rate smoothing and that the forecast horizon is not too far ahead

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 339.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:339
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  1. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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  4. Levine, Paul, 1986. "The formulation of robust policies for rival rational expectations models of the economy," Journal of Economic Dynamics and Control, Elsevier, vol. 10(1-2), pages 93-97, June.
  5. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules Under Model Uncertainty," American Economic Review, American Economic Association, vol. 93(3), pages 622-645, June.
  6. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 111-144, February.
  7. Robert J. Tetlow & Peter von zur Muehlen, 2000. "Robust monetary policy with misspecified models: does model uncertainty always call for attenuated policy?," Finance and Economics Discussion Series 2000-28, Board of Governors of the Federal Reserve System (U.S.).
  8. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
  9. Walsh, Carl E., 2004. "Implications of a Changing Economic Structure for the Strategy of Monetary Policy," Santa Cruz Center for International Economics, Working Paper Series qt84g1q1g6, Center for International Economics, UC Santa Cruz.
  10. Christopher J. Erceg and Andrew T. Levin, 2001. "Imperfect Credibility and Inflation Persistence," Computing in Economics and Finance 2001 19, Society for Computational Economics.
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  12. Ignazio Angeloni & Gunter Coenen & Frank Smets, 2003. "Persistence, The Transmission Mechanism And Robust Monetary Policy," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 527-549, November.
  13. Coenen, Gunter, 2007. "Inflation persistence and robust monetary policy design," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 111-140, January.
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  15. Nicoletta Batini & Joseph Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Discussion Papers 08, Monetary Policy Committee Unit, Bank of England.
  16. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
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  18. Ryan Banerjee & Nicoletta Batini, 2003. "UK Consumers’ Habits," Discussion Papers 13, Monetary Policy Committee Unit, Bank of England.
  19. Malcolm D. Knight & Chair, 2003. "Implications of a changing economic structure for the strategy of monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 361-371.
  20. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
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  23. Juillard, Michel & Karam, Philippe & Laxton, Douglas & Pesenti, Paolo, 2006. "Welfare-based monetary policy rules in an estimated DSGE model of the US economy," Working Paper Series 0613, European Central Bank.
  24. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
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