Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models

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We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data, and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.

Published: Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models, Andrew T. Levin, Alexei Onatski, John Williams, Noah M. Williams, in NBER Macroeconomics Annual 2005, Volume 20 (2006), MIT Press

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