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Monetary Policy with Model Uncertainty: Distribution Forecast Targeting

  • Noah Williams
  • Lars E.O. Svensson

We examine optimal and other monetary policies in a linear-quadratic setup with relatively general forms of model uncertainty. The forms of uncertainty our framework encompasses include: simple i.i.d. model deviations; serially correlated model deviations; estimable regime-switching models; more complex structural uncertainty, such as uncertainty about a set of structurally very different models, for instance, backward- and forward-looking models; 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 reaction 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 the more general certainty non-equivalence and "distribution forecast targeting."

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 108.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:108
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  1. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor principle," Research Working Paper RWP 05-13, Federal Reserve Bank of Kansas City.
  2. Christopher A. Sims, 2002. "The Role of Models and Probabilities in the Monetary Policy Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 1-62.
  3. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan Standard," Working Papers 88, Princeton University, Department of Economics, Center for Economic Policy Studies..
  4. Lars E.O. Svensson & Noah M. Williams, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," NBER Working Papers 13414, National Bureau of Economic Research, Inc.
  5. 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.
  6. Svensson, Lars O, 2005. "Monetary Policy with Judgment: Forecast Targeting," MPRA Paper 819, University Library of Munich, Germany.
  7. Sevensson, L.E.O., 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Papers 673, Stockholm - International Economic Studies.
  8. Linde, Jesper, 2005. "Estimating New-Keynesian Phillips curves: A full information maximum likelihood approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1135-1149, September.
  9. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
  10. Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers 1999, C.E.P.R. Discussion Papers.
  11. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388, June.
  12. 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.
  13. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," SSE/EFI Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
  14. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
  15. Alan Greenspan, 2005. "Reflections on central banking," Speech 126, Board of Governors of the Federal Reserve System (U.S.).
  16. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination in Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
  17. Onatski, Alexei & Williams, Noah, 2002. "Modeling model uncertainty," Working Paper Series 0169, European Central Bank.
  18. do Val, Joao B. R. & Basar, Tamer, 1999. "Receding horizon control of jump linear systems and a macroeconomic policy problem," Journal of Economic Dynamics and Control, Elsevier, vol. 23(8), pages 1099-1131, August.
  19. 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.
  20. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary policy under uncertainty in micro-founded macroeconometric models," Working Paper Series 2005-15, Federal Reserve Bank of San Francisco.
  21. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March.
  22. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  23. Fabrizio Zampolli & Andrew P. Blake, 2005. "Time Consistent Policy in Markov Switching Models," Computing in Economics and Finance 2005 134, Society for Computational Economics.
  24. Fabrizio Zampolli, 2004. "Optimal monetary policy in a regime-switching economy," Computing in Economics and Finance 2004 166, Society for Computational Economics.
  25. Kahn, James A. & Rich, Robert W., 2007. "Tracking the new economy: Using growth theory to detect changes in trend productivity," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1670-1701, September.
  26. Timothy Cogley & Riccardo Colacito & Thomas J. Sargent, 2007. "Benefits from U.S. Monetary Policy Experimentation in the Days of Samuelson and Solow and Lucas," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 67-99, 02.
  27. repec:cup:cbooks:9780521104609 is not listed on IDEAS
  28. 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.
  29. repec:fip:fedgns:2005roc is not listed on IDEAS
  30. Evan W. Anderson & Lars Peter Hansen & Ellen R. McGrattan & Thomas J. Sargent, 1995. "On the mechanics of forming and estimating dynamic linear economies," Staff Report 198, Federal Reserve Bank of Minneapolis.
  31. Chow, Gregory C, 1973. "Effect of Uncertainty on Optimal Control Policies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 14(3), pages 632-45, October.
  32. James H. Stock & Mark W. Watson, 2002. "Has the Business Cycle Changed and Why?," NBER Working Papers 9127, National Bureau of Economic Research, Inc.
  33. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
  34. Timothy Cogley & Thomas Sargent & Riccardo Colacito, 2005. "Benefits from U.S. Monetary Policy Experimentation in the Days of Samuelson," 2005 Meeting Papers 791, Society for Economic Dynamics.
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