Conference Paper

Robust estimation and monetary policy with unobserved structural change

Abstract: This paper considers the joint problem of model estimation and implementation of monetary policy in the face of uncertainty regarding the process of structural change in the economy. We model unobserved structural change through time variation in the natural rates of interest and unemployment. We show that certainty equivalent optimal policies perform poorly when there is model uncertainty about the natural rate processes. We then examine the properties of combined estimation methods and policy rules that are robust to this type of model uncertainty. We find that weighted averages of sample means perform well as estimators of natural rates. The optimal policy under uncertainty responds more aggressively to inflation and less so to the perceived unemployment gap then the certainty equivalent policy. This robust estimation/policy combination is highly effective at mitigating the effects of natural rate mismeasurement.

Keywords: Monetary policy; Uncertainty; Econometric models; Interest rates;

Status: Published in Models and monetary policy conference (2004: March 26-27, Washington DC)

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Proceedings

Publication Date: 2005

Pages: 53-81