Working Paper

Model uncertainty, robust policies, and the value of commitment

Abstract: Using results from the literature on H-control, this paper incorporates model uncertainty into Whiteman's (1986) frequency domain approach to stabilization policy. The derived policies guarantee a minimum performance level even in the worst of (a bounded set of) circumstances. ; For a given level of model uncertainty, robust H- policies are shown to be more 'activist' than Whiteman's H- policies in the sense that their impulse responses are larger. Robust policies also tend to be more autocorrelated. Consequently, the premium associated with being able to commit is greater under model uncertainty. Without commitment, the policymaker isn't able to (credibly) smooth his response to the degree that he would like. ; From a technical standpoint, a contribution of this paper is its analysis of robust control in a model featuring a forward-looking state transition equation, which arises from the fact that the private sector bases its decisions on expectations of future government policy. Existing applications of H- control in economics follow the engineering literature, and only consider backward-looking state transition equations. It is the forward-looking nature of the state transition equation that makes a frequency domain approach attractive.

Keywords: Econometric models; Programming (Mathematics);

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 1999

Number: 99-14