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Friday, September 09, 2005

Monetary Policy and the Brainard Principle

A recent post mentions the "Brainard Principle" in reference to monetary policy under uncertainty.  The Brainard Principle* states that policy should exhibit conservatism in the face of uncertainty.  There are exceptions to this principle in the literature and one occurs when the uncertainty involves the degree of persistence of inflation, an exception that may be operable today given recent events. In these models, an aggressive response rather than a conservative response is optimal.  Thus, determining which type of response, aggressive or conservative, is appropriate in the face of uncertainty is important.  This paper finds support for the Brainard Principle:

Zakovic, Stan, Rustem, Berc and Wieland, Volker, "Stochastic Optimization and Worst-Case Analysis in Monetary Policy Design" (April 2005). CEPR Discussion Paper No. 5019, [Author website version]:

Abstract In this paper, we compare expected loss minimization to worst-case or minimax analysis in the design of simple Taylor-style rules for monetary policy using a small model estimated for the euro area by Orphanides and Wieland (2000). We find that rules optimized under a minimax objective in the presence of general parameter and shock uncertainty do not imply extreme policy activism. Such rules tend to obey the Brainard principle of cautionary policy-making in much the same way as rules derived by expected loss minimization. Rules derived by means of minimax analysis are effective insurance policies limiting maximum loss over ranges of parameter values to be set by the policy-maker. In practice, we propose to set these ranges with an eye towards the cost of such insurance cover in terms of the implied increase in expected inflation variability.

*Brainard, W. (1967). "Uncertainty and the effectiveness of policy," American Economic Review, 57, pp 411-425.

    Posted by on Friday, September 9, 2005 at 02:43 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


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