Model Uncertainty, Optimal Monetary Policy and the Preferences of the Fed

22 Pages Posted: 3 Apr 2004

See all articles by Efrem Castelnuovo

Efrem Castelnuovo

University of Melbourne - Department of Economics

Paolo Surico

London Business School - Department of Economics; Centre for Economic Policy Research (CEPR)

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Abstract

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.

Suggested Citation

Castelnuovo, Efrem and Surico, Paolo, Model Uncertainty, Optimal Monetary Policy and the Preferences of the Fed. Scottish Journal of Political Economy, Vol. 51, pp. 105-126, February 2004. Available at SSRN: https://ssrn.com/abstract=514015

Efrem Castelnuovo (Contact Author)

University of Melbourne - Department of Economics ( email )

Melbourne, 3010
Australia

HOME PAGE: http://https://sites.google.com/site/efremcastelnuovo/home

Paolo Surico

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

HOME PAGE: http://sites.google.com/site/paolosurico

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://sites.google.com/site/paolosurico

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