Model Uncertainty, Optimal Monetary Policy and the Preferences of the Fed
University of Padua - Department of Economics
London Business School - Department of Economics; Centre for Economic Policy Research (CEPR)
Scottish Journal of Political Economy, Vol. 51, pp. 105-126, February 2004
Monetary policy in the US is characterized by a substantial degree of inertia. While in principle this may well be the outcome of an optimizing central bank behaviour, the ability of any derived policy rule to match the data relies on so large weights for interest rate smoothing into policy makers' preferences as to be theoretically flawed. In this paper we investigate whether such a puzzle can be interpreted as resulting from the concern of monetary authorities for potential misspecifications of the macroeconomic dynamics. Accordingly, we propose a novel thick modelling approach that incorporates model uncertainty into the identification of central bank's preferences. The thick robust policy rule shows the kind of smoothness observed in the data without resorting to implausible values for the preference parameters.
Number of Pages in PDF File: 22Accepted Paper Series
Date posted: April 3, 2004
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