| By: |
Keith Küster (Johann-Wolfgang-Goethe Universität, Mertonstrasse 17, D-60325 Frankfurt am Main, Germany);
Volker Wieland (Professur für Geldtheorie und -politik, Johann-Wolfgang-Goethe Universität, Mertonstrasse 17, D-60325 Frankfurt am Main, Germany) |
| Abstract: |
In this paper, we examine the cost of insurance against model uncertainty for
the Euro area considering four alternative reference models, all of which are
used for policy-analysis at the ECB. We find that maximal insurance across
this model range in terms of a Minimax policy comes at moderate costs in terms
of lower expected performance. We extract priors that would rationalize the
Minimax policy from a Bayesian perspective. These priors indicate that full
insurance is strongly oriented towards the model with highest baseline losses.
Furthermore, this policy is not as tolerant towards small perturbations of
policy parameters as the Bayesian policy rule. We propose to strike a
compromise and use preferences for policy design that allow for intermediate
degrees of ambiguity-aversion. These preferences allow the specification of
priors but also give extra weight to the worst uncertain outcomes in a given
context. |
| Keywords: |
Model uncertainty; robustness; monetary policy rules; minimax; euro area. |
| JEL: |
E52 E58 E61 |
| Date: |
2005–04 |
| URL: |
http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050480&r=ias |