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Caution in Macroeconomic Policy: Uncertainty and the Relative Intensity of Policy

Author

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  • P. Ruben Mercado

    () (Bryn Mawr College)

  • David Kendrick

    () (University of Texas)

Abstract

Two lines of literature show that increased uncertainty results in decreased vigor of the control variable in the first time period. The first line uses static models, the second dynamic. Here, the dynamic line is extended from one-state, one-control models to ones with two control variables. We confirm the Johansen result from the static line that, in this case, one control is used less intensely and the other more intensely when current uncertainty is increased. We then extend this result to models with zero weights on the controls, giving a linear complementarity outcome. Analyses from both lines of the literature effectively involve single-period results, since even the dynamic line has focused on the effects of current uncertainty. Here we follow a suggestion from Craine to extend the results to a multiperiod framework. Using the Riccati equations, we study the effects of increased uncertainty in a future time period on the use of controls in the first time period. We find, contrary to the single-period results, that the outcomes reveal that both control variables (or at least one, depending of the relative magnitude of first-period control parameter weighted variances) are used more, rather than less, intensely.

Suggested Citation

  • P. Ruben Mercado & David Kendrick, 1999. "Caution in Macroeconomic Policy: Uncertainty and the Relative Intensity of Policy," Computing in Economics and Finance 1999 1343, Society for Computational Economics.
  • Handle: RePEc:sce:scecf9:1343
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    File URL: http://www.eco.utexas.edu/faculty/Kendrick/papers/CautionI.pdf
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    References listed on IDEAS

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    1. Pohjola, Matti T., 1981. "Uncertainty and the vigour of policy Some implications of quadratic preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 3(1), pages 299-305, November.
    2. Shupp, Franklin R., 1976. "Uncertainty and optimal stabilization policy," Journal of Public Economics, Elsevier, vol. 6(3), pages 243-253, October.
    3. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
    4. Amman, Hans M & Kendrick, David A, 1999. "Should Macroeconomic Policy Makers Consider Parameter Covariances?," Computational Economics, Springer;Society for Computational Economics, vol. 14(3), pages 263-267, December.
    5. Hans M. Amman & David A. Kendrick, 1996. "The DUALI/DUALPC Software for Optimal Control Models: Introduction," CARE Working Papers 9602, The University of Texas at Austin, Center for Applied Research in Economics.
    6. Franklin R. Shupp, 1976. "Uncertainty and Optimal Policy Intensity in Fiscal and Incomes Policies," NBER Chapters,in: Annals of Economic and Social Measurement, Volume 5, number 2, pages 225-237 National Bureau of Economic Research, Inc.
    7. 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 632-645, October.
    8. Turnovsky, Stephen J, 1975. "Optimal Choice of Monetary Instrument in a Linear Economic Model with Stochastic Coefficients," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 7(1), pages 51-80, February.
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    Cited by:

    1. Engwerda, Jacob & Mahmoudinia, D. & Isfahani, Rahim Dalali, 2016. "Government and Central Bank Interaction under uncertainty : A Differential Games Approach," Discussion Paper 2016-012, Tilburg University, Center for Economic Research.
    2. P. Ruben Mercado, 2004. "The Timing of Uncertainty and the Intensity of Policy," Computational Economics, Springer;Society for Computational Economics, vol. 23(4), pages 303-313, June.
    3. Fidel Gonzalez, 2008. "Optimal Policy Response with Control Parameter and Intercept Covariance," Computational Economics, Springer;Society for Computational Economics, vol. 31(1), pages 1-20, February.
    4. Arnulfo Rodriguez, 2004. "Robust Control: A Note on the Timing of Model Uncertainty," Computing in Economics and Finance 2004 147, Society for Computational Economics.
    5. Fidel Gonzalez & Arnulfo Rodriguez, 2004. "Robust Control: A Note on the Response of the Control to Changes in the “Free” Parameter Conditional on the Character of Nature," Computational Economics, Springer;Society for Computational Economics, vol. 24(3), pages 223-238, March.
    6. P. Mercado & David Kendrick, 2006. "Parameter Uncertainty and Policy Intensity: Some Extensions and Suggestions for Further Work," Computational Economics, Springer;Society for Computational Economics, vol. 27(4), pages 483-496, June.
    7. Arnulfo Rodriguez, 2004. "Robust Control: A Note on the Timing of Model Uncertainty," Computational Economics, Springer;Society for Computational Economics, vol. 24(3), pages 209-221, July.
    8. Gonzalez, Fidel & Rodriguez, Arnulfo, 2005. "Robust control: A note on the response of the control to changes in the "free" parameter," Economics Letters, Elsevier, vol. 89(3), pages 294-299, December.
    9. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 911-949, June.
    10. mercado, p. ruben, 2003. "Empirical economywide modeling in argentina," MPRA Paper 58611, University Library of Munich, Germany.
    11. André P. Calmon & Thomas Vallée & João B. R. Do Val, 2009. "Monetary policy as a source of uncertainty," Working Papers hal-00422454, HAL.
    12. Ric D. Herbert and Rod D. Bell, 2001. "Constrained Optimal Control Under Limited Knowledge," Computing in Economics and Finance 2001 14, Society for Computational Economics.

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