Won’t Get Fooled Again – Or Will We? Monetary Policy, Model Uncertainty, and ‘Policy Model Complacency’

Mark Setterfield

No 1516, Working Papers from New School for Social Research, Department of Economics

Abstract: The question addressed in this paper is: can monetary policy succeed in stabilizing the economy even when the policy model on which it is predicated is mis-specified? Using variants of the 3-equation New Consensus Macroeconomics model, it is shown that this question can be answered in the affirmative. The purpose of the paper is not to encourage indifference towards model uncertainty, however, but rather to warn against the perils of “policy model complacency”. This arises if the success of policy is misinterpreted as successful understanding of the workings of the economy, which makes the policy maker vulnerable to surprises: events with systematic origins in the “true” model of the economy that are not anticipated by the (mis-specified) policy model. To safeguard against this problem, policy makers should always entertain eclectic views of the workings of the economy – a task that is easily accomplished by paying more attention to “outside the mainstream” macroeconomic thinking that frequently makes predictions that are at odds with those of the dominant policy model.

Keywords: Monetary policy; central banking; model uncertainty; Lucas critique; Tinbergen principle (search for similar items in EconPapers)
JEL-codes: E12 E13 E52 E58 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2015-07, Revised 2016-01
New Economics Papers: this item is included in nep-hpe, nep-mac, nep-mon and nep-pke
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:new:wpaper:1516

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