Robustness and U.S. Monetary Policy Experimentation

Abstract:     
We study how a concern for robustness modifies a policy maker's incentive to experiment. A policy maker has a prior over two submodels of inflation-unemployment dynamics. One submodel implies an exploitable trade-off, the other does not. Bayes' law gives the policy maker an incentive to experiment. The policy maker fears that both submodels and his prior probability distribution over them are misspecified. We compute decision rules that are robust to misspecifications of each submodel and of the prior distribution over sub-models. We compare robust rules to ones that Cogley, Colacito, and Sargent (2007) computed assuming that the models and the prior distribution are correctly specified. We explain how the policy maker's desires to protect against misspecifications of the submodels, on the one hand, and misspecifications of the prior over them, on the other, have different effects on the decision rule.

Keywords: Learning, model uncertainty, Bayes' law, Phillips curve, experimentation, robustness, pessimism, entropy

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