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Monetary Policy in an Uncertain World: Probability Models and the Design of Robust Monetary Rules

  • Paul Levine

    (University of Surrey)

The past forty years or so has seen a remarkable transformation in macro-models used by central banks, policymakers and forecasting bodies. This papers describes this transformation from reduced-form behavioural equations estimated separately, through to contemporarymicro-founded dynamic stochastic general equilibrium (DSGE) models estimated by systems methods. In particular by treating DSGE models estimated by Bayesian-Maximum-Likelihood methods I argue that they can be considered as probability models in the sense described by Sims (2007) and be used for risk-assessment and policy design. This is true for any one model, but with a range of models on offer it is possible also to design interest rate rules that are simple and robust across the rival models and across the distribution of parameter estimates for each of these rivals as in Levine et al. (2008). After making models better in a number of important dimensions, a possible road ahead is to consider rival models as being distinguished by the model of expectations. This would avoid becoming 'a prisoner of a single system' at least with respect to expectations formation where, as I argue, there is relatively less consensus on the appropriate modelling strategy.

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Paper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 0210.

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Length: 22 pages
Date of creation: Apr 2010
Handle: RePEc:sur:surrec:0210
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