Working Paper: NBER ID: w11733
Authors: Lars E.O. Svensson; Noah Williams
Abstract: We examine optimal and other monetary policies in a linear-quadratic setup with a relatively general form of model uncertainty, so-called Markov jump-linear-quadratic systems extended to include forward-looking variables. The form of model uncertainty our framework encompasses includes: simple i.i.d. model deviations; serially correlated model deviations; estimable regime-switching models; more complex structural uncertainty about very different models, for instance, backward- and forward-looking models; time-varying 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 policy 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 more general certainty non-equivalence and "distribution forecast targeting."
Keywords: No keywords provided
JEL Codes: E42; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| model uncertainty (D80) | optimal monetary policies (E63) |
| model deviations (C59) | adjustments in policy responses (E63) |
| mode of uncertainty (D80) | policy effectiveness (D78) |
| transition probabilities of the modes (C69) | dynamics of the model (C69) |
| greater uncertainty (D89) | less aggressive policy responses (E65) |