Central Bankers' Preferences and Attitudes Towards Uncertainty

Can we identify preferences of a central bank and her attitude towards model uncertainty? Not if we restrict our attention to commonly used observable macro time series (in the context of monetary models, say, interest rates... [ view full abstract ]

Can we identify preferences of a central bank and her attitude towards model uncertainty? Not if we restrict our attention to commonly used observable macro time series (in the context of monetary models, say, interest rates set by the
central bank, inflation and unemployment). Yes, if we make an informed use of asset prices.
This paper constructs an observational equivalence result between standard optimal control problems based on rational expectations paradigm and robust control theory in which a decision maker is assumed to be faced with model uncertainty: According to the finding, the same optimal policy rule will be chosen by a central banker with rational expectations who fully trusts his model as well as by a robust policy maker who acknowledges model uncertainty and whose preferences are appropriately augmented to offset his fears about model misspeci�cation.

What breaks the equivalence and restores identi�cation is the use of asset prices as
two economies with identical macro outcomes are shown to be associated with different underlying asset prices depending on central banker�s attitude towards model uncertainty, ceteris paribus. This result reopens the discussion on the desirability of targetting asset prices when setting monetary policy pioneered by Bernanke and Gertler (2000).