The Timing of Uncertainty and the Intensity of Policy

Ruben Mercado ()

Computational Economics, 2004, vol. 23, issue 4, 303-313

Abstract: This article analyzes the trade-off between `caution' and `intensity' in the use of the control variable in a one-state one-control dynamic stochastic quadratic linear optimization problem with discount factor. It studies the effects that changes in uncertainty of the control parameter have on the optimal first period response of the control variable, showing that the trade-off between `caution' and `intensity' depends on the timing of the uncertainty. Given an increase in current uncertainty and an equal increase in future uncertainty, caution will always prevail over intensity. Moreover, the prevalence of caution will be enlarged as the increase in future uncertainty moves farther away into the future, while this prevalence will be reduced as the increase in future uncertainty expands into the future. Finally, for the infinite horizon case, caution is the optimal policy response.

Date: 2004
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