A Bayesian Approach to Optimal Monetary Policy with Parameter and Model Uncertainty

74 Pages Posted: 18 Mar 2011

See all articles by Timothy Cogley

Timothy Cogley

Leonard N. Stern School of Business - Department of Economics

Bianca De Paoli

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Christian Matthes

Federal Reserve Bank of Richmond

Kalin Nikolov

European Central Bank (ECB)

Tony Yates

affiliation not provided to SSRN

Date Written: March 2, 2011

Abstract

This paper undertakes a Bayesian analysis of optimal monetary policy for the United Kingdom. We estimate a suite of monetary policy models that include both forward and backward-looking representations as well as large and small-scale models. We find an optimal simple Taylor-type rule that accounts for both model and parameter uncertainty. For the most part, backward-looking models are highly fault tolerant with respect to policies optimised for forward-looking representations, while forward-looking models have low fault tolerance with respect to policies optimised for backward-looking representations. In addition, backward-looking models often have lower posterior probabilities than forward-looking models. Bayesian policies therefore have characteristics suitable for inflation and output stabilisation in forward-looking models.

Suggested Citation

Cogley, Timothy and De Paoli, Bianca and Matthes, Christian and Nikolov, Kalin and Yates, Tony, A Bayesian Approach to Optimal Monetary Policy with Parameter and Model Uncertainty (March 2, 2011). Bank of England Working Paper No. 414. Available at SSRN: https://ssrn.com/abstract=1786583 or http://dx.doi.org/10.2139/ssrn.1786583

Timothy Cogley

Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
530-752-1581 (Phone)
530-752-9382 (Fax)

Bianca De Paoli

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Christian Matthes

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Kalin Nikolov

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Tony Yates (Contact Author)

affiliation not provided to SSRN ( email )

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