Robustness and U.S. Monetary Policy Experimentation

Timothy Cogley, Riccardo Colacito, Lars Peter Hansen, Thomas J. Sargent

    Research output: Contribution to journalArticle

    Abstract

    We study how a concern for robustness modifies a policymaker's incentive to experiment. A policymaker has a prior over two submodels of inflation-unemployment dynamics. One submodel implies an exploitable trade-off, the other does not. Bayes' law gives the policymaker an incentive to experiment. The policymaker fears that both submodels and his prior probability distribution over them are misspecified. We compute decision rules that are robust to misspecifications of each submodel and of the prior distribution over submodels. We compare robust rules to ones that Cogley, Colacito, and Sargent (2007) computed assuming that the models and the prior distribution are correctly specified. We explain how the policymaker's desires to protect against misspecifications of the submodels, on the one hand, and misspecifications of the prior over them, on the other, have different effects on the decision rule.

    Original languageEnglish (US)
    Pages (from-to)1599-1623
    Number of pages25
    JournalJournal of Money, Credit and Banking
    Volume40
    Issue number8
    DOIs
    StatePublished - Dec 1 2008

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    Keywords

    • Bayes' law
    • Entropy
    • Experimentation
    • Learning
    • Model uncertainty
    • Pessimism
    • Phillips curve
    • Robustness

    ASJC Scopus subject areas

    • Accounting
    • Finance
    • Economics and Econometrics

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