Essays on model uncertainty in macroeconomics
My dissertation grapples with the issues of model uncertainty in macroeconomics,
and analyzes its consequences for monetary policy. It consists of three essays.
In the first essay (Chapter 1), “Monetary Policy under Misspecified Expectations”,
I examine policy choices for the central bank that faces uncertainty about the process
of expectation formation by economic agents. The economy contains both “rule-ofthumb”
agents who base their expectations on recent observations and agents who
have rational expectations. The central bank is uncertain about the fraction of the
rule-of-thumb agents. This uncertainty concern enables me to partially rationalize the
over cautious policy stance of the Fed: empirically observed policy in the past two
decades involves much weaker responses than optimal policies derived from various
micro-founded models. It is well understood that when the economy is more forwardlooking,
the central bank displays more aggressive responses to inflation and output.
But the uncertainty-averse central bank evaluates policies by the performance in the
worst case. In my economy this has a high fraction of agents that are backwardlooking.
The best policy the central bank chooses thus involves moderate responses.
That is to say, this minimax policy moves closer toward actual less responsive policy.
In the second essay (Chapter 2), “Phillips Curve Uncertainty and Monetary Policy”,
I investigate the effect of model uncertainty on policy choices employing a more
general approach, which nests the minimax and Bayesian approaches as limiting cases.
The central bank is uncertain about whether the economy has a sticky price Phillips
curve or a sticky information Phillips curve. I argue that how the central bank
chooses a policy depends both on its perception of uncertainty environment and on
its attitude towards uncertainty. I find that as the central bank either becomes more
uncertainty-averse or considers sticky information more plausible, the response to
inflation decreases and to output increases.
The third essay (Chapter 3) is entitled “Optimal Simple Rules in RE Models with
Risk Sensitive Preferences”. This paper provides a useful method to solve optimal
simple rules under risk sensitive preference in macro models with forward looking
behavior. An application to a new Keynesian model with lagged dynamics is offered
and risk sensitive preference is found to amplify policy responses.
This is dedicated to my parents.
School:The Ohio State University
School Location:USA - Ohio
Source Type:Master's Thesis
Keywords:monetary policy uncertainty financial risk management robust control taylor s rule phillips curve rational expectations economic theory bayesian statistical decision
Date of Publication: