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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
Date of revision:
Handle: RePEc:sce:scecf5:108
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  1. 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.
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  8. Troy Davig & Eric M. Leeper, 2007. "Generalizing the Taylor Principle," American Economic Review, American Economic Association, vol. 97(3), pages 607-635, June.
  9. Svensson, Lars E O, 2005. "Monetary Policy with Judgement: Forecast Targeting," CEPR Discussion Papers 5072, C.E.P.R. Discussion Papers.
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  12. 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.
  13. 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.
  14. Svensson, Lars E. O. & Williams, Noah, 2006. "Bayesian and adaptive optimal policy under model uncertainty," CFS Working Paper Series 2007/11, Center for Financial Studies (CFS).
  15. James H. Stock & Mark W. Watson, 2003. "Has the Business Cycle Changed and Why?," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 159-230 National Bureau of Economic Research, Inc.
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  31. repec:fip:fedgns:2005roc is not listed on IDEAS
  32. 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.
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