url
3
Aug
2014

SIMPLE MONETARY POLICY RULES UNDER MODEL UNCERTAINTY: NOTES

1. We use the term “model uncertainty” to refer to lack of knowledge about which model among a given set of alternatives provides the best description of the economy. For a particular model, we treat the estimated parameters as known with certainty. A very limited literature exists on the problem of conducting monetary policy under model uncertainty (Becker et al. 1986; Frankel and Rockett 1988; Holtham and Hughes-Hallett 1992; and Christodoulakis et al. 1993). Optimal policy under parameter uncertainty was investigated in the seminal paper of Brainard (1967), and was extended by the work of Kendrick (1982) and others; the more recent literature includes Balvers and Cosimano (1993) and Wieland (1996b, 1997).


2. MSR is a small macroeconometric model of the U.S. economy from 1980 to 1996, developed and used for research on monetary policy rules in the Monetary Studies Section at the Federal Reserve Board (e.g., Orphanides et al. 1997).

3. The literature on policy evaluation using traditional structural models is large and includes important contributions by Cooper and Fischer (1977) and Poole (1970). In recent papers, Fair and Howrey (1996), Ball (1997), and Rudebusch and Svensson (1998) derive optimal policies from traditional structural macroeconomic models.

4. Williams (1997) compares the characteristics of optimal policies under rational expectations and alternative assumptions regarding expectations formation using the FRB staff model.

5. Taylor (1979) and, more recently, Fuhrer (1997a), Svensson (1997a), and Tetlow and von zur Muehlen (1997), derive optimal policies in small rational expectations structural macro models.

6. This nonlinearity has been investigated in both of the smaller models used here. Fuhrer and Madigan (1997) conducted deterministic simulations of the Fuhrer-Moore model to assess the extent to which the zero bound prevents real rates from falling and thus cushioning aggregate output in response to negative spending shocks. Orphanides and Wieland (1997), using stochastic simulations of MSR, find that the effectiveness of monetary policy is significantly reduced at inflation targets below 1%. They find that the distortions due to the zero bound generate a non-vertical long run Phillips curve and result in higher inflation and output variability.

1. We use the term “model uncertainty” to refer to lack of knowledge about which model among a given set of alternatives provides the best description of the economy. For a particular model, we treat the estimated parameters as known with certainty. A very limited literature exists on the problem of conducting monetary policy under model uncertainty (Becker et al. 1986; Frankel and Rockett 1988; Holtham and Hughes-Hallett 1992; and Christodoulakis et al. 1993). Optimal policy under parameter uncertainty was investigated in the seminal paper of Brainard (1967), and was extended by the work of Kendrick (1982) and others; the more recent literature includes Balvers and Cosimano (1993) and Wieland (1996b, 1997). 2. MSR is a small macroeconometric model of the

About The Author

Kevin J. Brandon

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