Insurance policies for monetary policy in the euro area

Keith Kuester and Volker Wieland

No 08-29, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: In this paper, the authors aim to design a monetary policy for the euro area that is robust to the high degree of model uncertainty at the start of monetary union and allows for learning about model probabilities. To this end, they compare and ultimately combine Bayesian and worst-case analysis using four reference models estimated with pre-EMU synthetic data. The authors start by computing the cost of insurance against model uncertainty, that is, the relative performance of worst-case or minimax policy versus Bayesian policy. While maximum insurance comes at moderate costs, they highlight three shortcomings of this worst-case insurance policy: (i) prior beliefs that would rationalize it from a Bayesian perspective indicate that such insurance is strongly oriented toward the model with highest baseline losses; (ii) the minimax policy is not as tolerant of small perturbations of policy parameters as the Bayesian policy; and (iii) the minimax policy offers no avenue for incorporating posterior model probabilities derived from data available since monetary union. Thus, the authors propose preferences for robust policy design that reflect a mixture of the Bayesian and minimax approaches. They show how the incoming EMU data may then be used to update model probabilities, and investigate the implications for policy. ; Forthcoming in the Journal of the European Economic Association.

Keywords: Monetary policy - Europe; Monetary policy - Mathematical models (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cba, nep-eec, nep-ias, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Insurance Policies for Monetary Policy in the Euro Area (2010)
Journal Article: Insurance Policies for Monetary Policy in the Euro Area (2010)
Working Paper: Insurance Policies for Monetary Policy in the Euro Area (2008)
Working Paper: Insurance Policies for Monetary Policy in the Euro Area (2005)
Working Paper: Insurance policies for monetary policy in the euro area (2005)
Working Paper: Insurance Policies for Monetary Policy in the Euro Area (2005)
Working Paper: Insurance policies for monetary policy in the Euro area (2005)
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