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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. 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.
  2. 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).
  3. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Working Papers in Applied Economic Theory 98-03, Federal Reserve Bank of San Francisco.
  4. 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.
  5. Svensson, Lars O, 2005. "Monetary Policy with Judgment: Forecast Targeting," MPRA Paper 819, University Library of Munich, Germany.
  6. 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.
  7. James A. Kahn & Robert W. Rich, 2003. "Tracking the new economy: using growth theory to detect changes in trend productivity," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  8. Noah Williams & Andrew Levin & Alexei Onatski, 2005. "Monetary Policy under Uncertainty in Micro-Founded Macroeconometric Models," Computing in Economics and Finance 2005 478, Society for Computational Economics.
  9. 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.
  10. 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.
  11. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan Standard," Working Papers 88, Princeton University, Department of Economics, Center for Economic Policy Studies..
  12. Lindé, Jesper, 2001. "Estimating New-Keynesian Phillips Curves: A Full Information Maximum Likelihood Approach," Working Paper Series 129, Sveriges Riksbank (Central Bank of Sweden), revised 30 Apr 2001.
  13. Zampolli, Fabrizio, 2006. "Optimal monetary policy in a regime-switching economy: The response to abrupt shifts in exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1527-1567.
  14. Alexei Onatski & Noah Williams, 2003. "Modeling Model Uncertainty," NBER Working Papers 9566, National Bureau of Economic Research, Inc.
  15. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Economics Working Papers ECO2011/15, European University Institute.
  16. Troy Davig & Eric M. Leeper, 2007. "Generalizing the Taylor Principle," American Economic Review, American Economic Association, vol. 97(3), pages 607-635, June.
  17. Svensson, Lars O & Tetlow, Robert J, 2005. "Optimal Policy Projections," MPRA Paper 839, University Library of Munich, Germany.
  18. Fabrizio Zampolli & Andrew Blake, 2005. "Time Consistent Policy in Markov Switching Models," Money Macro and Finance (MMF) Research Group Conference 2005 2, Money Macro and Finance Research Group.
  19. Lars E. O. Svensson & Michael Woodford, 2003. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Working Papers 9747, National Bureau of Economic Research, Inc.
  20. James H. Stock & Mark W. Watson, 2002. "Has the Business Cycle Changed and Why?," NBER Working Papers 9127, National Bureau of Economic Research, Inc.
  21. Roger E. A. Farmer & Daniel F. Waggoner & Tao Zha, 2007. "Understanding the New Keynesian model when monetary policy switches regimes," FRB Atlanta Working Paper 2007-12, Federal Reserve Bank of Atlanta.
  22. 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.
  23. 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.
  24. 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.
  25. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
  26. Alan Greenspan, 2005. "Reflections on central banking," Speech 126, Board of Governors of the Federal Reserve System (U.S.).
  27. 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.
  28. 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.
  29. repec:fip:fedgns:2005roc is not listed on IDEAS
  30. Fabrizio Zampolli, 2004. "Optimal monetary policy in a regime-switching economy," Computing in Economics and Finance 2004 166, Society for Computational Economics.
  31. 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.
  32. Noah Williams & Lars E.O. Svensson, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," 2007 Meeting Papers 446, Society for Economic Dynamics.
  33. 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.
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