Robust Control and Monetary Policy Delegation

Abstract

In the recent literature on optimal monetary policy, policymakers are assumed to know the true model of the economy and observe accurately all relevant variables. The sources and properties of economic disturbance are also taken to be known. Uncertainty in this case arises only due to the unknown future realisations of these disturbances. In this context, “uncertainty” means the realisation of an event whose true probability distribution is known. Pure uncertainty, where the state space of outcomes is known but one is unable to assign probabilities, has largely been ignored. In practice, the policymaker’s choice is made in the face of tremendous uncertainty about the true structure of the economy, the impact policy actions have on the economy, and even about the current state of the economy. The policymaker is therefore unsure about his model, in the sense that there is a group of approximate models that he also considers as possibly true. Because uncertainty is pervasive, it is important to understand how alternative policies work when the policymaker cannot accurately observe important macro variables or when he employs a model of the economy that is incorrect in unknown ways.