Discussion Paper

Model Uncertainty and Policy Design

Abstract: This article illustrates the main challenges and forces that emerge in optimal policy design when there are doubts about the probability model of uncertainty. Model doubts can stem from either the side of the public or the side of the policymaker, and they can give rise to cautious probabilistic assessments. A basic idea that surfaces in setups with model uncertainty is the management of the public's pessimistic expectations by the policymaker. The article also presents several implications of this idea.

Keywords: Model uncertainty; ambiguity aversion; multiplier preferences; misspecification; pessimistic expectations; paternalism; taxation; austerity; competitive fringe;

JEL Classification: D80; E62; H21; H63;

https://doi.org/10.29338/ph2020-17

Bibliographic Information

Provider: Federal Reserve Bank of Atlanta

Part of Series: Policy Hub*

Publication Date: 2020-12-22

Number: 2020-17