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John C. Williams - One of the best experts on this subject based on the ideXlab platform.
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Imperfect Knowledge and the Pitfalls of Optimal Control Monetary Policy
Research Papers in Economics, 2008Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations formation and uncertainty about the natural rates of interest and unemployment. We assume that agents have Imperfect Knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We also allow for central bank uncertainty regarding the natural rates of interest and unemployment. We find that the optimal control policy derived under the assumption of perfect Knowledge about the structure of the economy can perform poorly when Knowledge is Imperfect. These problems are exacerbated by natural rate uncertainty, even when the central bank's estimates of natural rates are efficient. We show that the optimal control approach can be made more robust to the presence of Imperfect Knowledge by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to the presence of Imperfect Knowledge about the economy provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to the alternative models of learning that we study and natural rate uncertainty and outperform the optimal control policy and generally perform as well as the robust optimal control policy that places less weight on stabilizing economic activity and interest rates.
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Imperfect Knowledge and the Pitfalls of Optimal Control Monetary Policy
Federal Reserve Bank of San Francisco Working Paper Series, 2008Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:Este documento analiza la robustez de las politicas de control optimo derivadas bajo el supuesto de expectativas racionales en modelos con formacion alternativa de expectativas y con tasas naturales de interes y de desempleo inciertas. Se supone que los agentes tienen informacion Imperfecta sobre la estructura precisa de la economia y que forman sus expectativas usando un modelo de proyeccion que actualizan constantemente con nueva informacion. Tambien se permite incertidumbre del banco central respecto de las tasas naturales de interes y de empleo. Se encuentra que la politica de control optimo que se deriva bajo el supuesto de expectativas racionales es mediocre cuando los agentes aprenden, condicion que se agrava con dicha incertidumbre, aun cuando las tasas naturales del banco central son eficientes. Luego se revisan dos tipos de reglas simples de politica monetaria tomadas de la literatura, que han resultado robustas frente a la mala especificacion de los modelos en otros contextos. Se encuentra que estas politicas son robustas frente a los modelos alternativos de aprendizaje estudiados y a la incertidumbre sobre la tasa natural y superan a la politica de control optimo en parametrizaciones empiricamente plausibles de los modelos de aprendizaje y de tasas naturales.
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robust monetary policy with Imperfect Knowledge
Social Science Research Network, 2007Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess Imperfect Knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy's natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation: rational expectations and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under rational expectations with perfect Knowledge. Furthermore, policies that would be optimal under perfect Knowledge can perform very poorly if Knowledge is Imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect Knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates.
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Inflation targeting under Imperfect Knowledge
Econometric Reviews, 2007Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:A central tenet of inflation targeting is that establishing and maintaining well-anchored inflation expectations are essential. In this paper, we reexamine the role of key elements of the inflation targeting framework towards this end, in the context of an economy where economic agents have an Imperfect understanding of the macroeconomic landscape within which the public forms expectations and policymakers must formulate and implement monetary policy. Using an estimated model of the U.S. economy, we show that monetary policy rules that would perform well under the assumption of rational expectations can perform very poorly when we introduce Imperfect Knowledge. We then examine the performance of an easily implemented policy rule that incorporates three key characteristics of inflation targeting: transparency, commitment to maintaining price stability, and close monitoring of inflation expectations, and find that all three play an important role in assuring its success. Our analysis suggests that simple difference rules in the spirit of Knut Wicksell excel at tethering inflation expectations to the central banks goal and in so doing achieve superior stabilization of inflation and economic activity in an environment of Imperfect Knowledge.
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Robust Monetary Policy with Imperfect Knowledge
Journal of Monetary Economics, 2007Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess Imperfect Knowledge about the true structure of the economy. Private agents rely on an adaptive learning technology to form expectations and update their beliefs based on incoming data. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize ∞uctuations of unemployment around its natural rate but are uncertain about the economy’s natural rates of interest and unemployment. We show that in this environment the scope for economic stabilization is signiflcantly reduced relative to an economy under rational expectations with perfect Knowledge. Furthermore, policies that would be optimal under perfect Knowledge can perform very poorly when Knowledge is Imperfect. E‐cient policies that take account of private learning and misperceptions of natural rates call for more aggressive responses to in∞ation that would be optimal under perfect Knowledge. We show that such policies not only improve performance in our baseline model, but are also quite robust to potential misspeciflcation of private sector learning and the magnitude of variation in natural rates.
Athanasios Orphanides - One of the best experts on this subject based on the ideXlab platform.
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Imperfect Knowledge and the Pitfalls of Optimal Control Monetary Policy
Research Papers in Economics, 2008Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations formation and uncertainty about the natural rates of interest and unemployment. We assume that agents have Imperfect Knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We also allow for central bank uncertainty regarding the natural rates of interest and unemployment. We find that the optimal control policy derived under the assumption of perfect Knowledge about the structure of the economy can perform poorly when Knowledge is Imperfect. These problems are exacerbated by natural rate uncertainty, even when the central bank's estimates of natural rates are efficient. We show that the optimal control approach can be made more robust to the presence of Imperfect Knowledge by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to the presence of Imperfect Knowledge about the economy provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to the alternative models of learning that we study and natural rate uncertainty and outperform the optimal control policy and generally perform as well as the robust optimal control policy that places less weight on stabilizing economic activity and interest rates.
-
Imperfect Knowledge and the Pitfalls of Optimal Control Monetary Policy
Federal Reserve Bank of San Francisco Working Paper Series, 2008Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:Este documento analiza la robustez de las politicas de control optimo derivadas bajo el supuesto de expectativas racionales en modelos con formacion alternativa de expectativas y con tasas naturales de interes y de desempleo inciertas. Se supone que los agentes tienen informacion Imperfecta sobre la estructura precisa de la economia y que forman sus expectativas usando un modelo de proyeccion que actualizan constantemente con nueva informacion. Tambien se permite incertidumbre del banco central respecto de las tasas naturales de interes y de empleo. Se encuentra que la politica de control optimo que se deriva bajo el supuesto de expectativas racionales es mediocre cuando los agentes aprenden, condicion que se agrava con dicha incertidumbre, aun cuando las tasas naturales del banco central son eficientes. Luego se revisan dos tipos de reglas simples de politica monetaria tomadas de la literatura, que han resultado robustas frente a la mala especificacion de los modelos en otros contextos. Se encuentra que estas politicas son robustas frente a los modelos alternativos de aprendizaje estudiados y a la incertidumbre sobre la tasa natural y superan a la politica de control optimo en parametrizaciones empiricamente plausibles de los modelos de aprendizaje y de tasas naturales.
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robust monetary policy with Imperfect Knowledge
Social Science Research Network, 2007Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess Imperfect Knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy's natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation: rational expectations and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under rational expectations with perfect Knowledge. Furthermore, policies that would be optimal under perfect Knowledge can perform very poorly if Knowledge is Imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect Knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates.
-
Inflation targeting under Imperfect Knowledge
Econometric Reviews, 2007Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:A central tenet of inflation targeting is that establishing and maintaining well-anchored inflation expectations are essential. In this paper, we reexamine the role of key elements of the inflation targeting framework towards this end, in the context of an economy where economic agents have an Imperfect understanding of the macroeconomic landscape within which the public forms expectations and policymakers must formulate and implement monetary policy. Using an estimated model of the U.S. economy, we show that monetary policy rules that would perform well under the assumption of rational expectations can perform very poorly when we introduce Imperfect Knowledge. We then examine the performance of an easily implemented policy rule that incorporates three key characteristics of inflation targeting: transparency, commitment to maintaining price stability, and close monitoring of inflation expectations, and find that all three play an important role in assuring its success. Our analysis suggests that simple difference rules in the spirit of Knut Wicksell excel at tethering inflation expectations to the central banks goal and in so doing achieve superior stabilization of inflation and economic activity in an environment of Imperfect Knowledge.
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Robust Monetary Policy with Imperfect Knowledge
Journal of Monetary Economics, 2007Co-Authors: Athanasios Orphanides, John C. WilliamsAbstract:We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess Imperfect Knowledge about the true structure of the economy. Private agents rely on an adaptive learning technology to form expectations and update their beliefs based on incoming data. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize ∞uctuations of unemployment around its natural rate but are uncertain about the economy’s natural rates of interest and unemployment. We show that in this environment the scope for economic stabilization is signiflcantly reduced relative to an economy under rational expectations with perfect Knowledge. Furthermore, policies that would be optimal under perfect Knowledge can perform very poorly when Knowledge is Imperfect. E‐cient policies that take account of private learning and misperceptions of natural rates call for more aggressive responses to in∞ation that would be optimal under perfect Knowledge. We show that such policies not only improve performance in our baseline model, but are also quite robust to potential misspeciflcation of private sector learning and the magnitude of variation in natural rates.
Michael D. Goldberg - One of the best experts on this subject based on the ideXlab platform.
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Macroeconomic Theory for a World of Imperfect Knowledge
Social Science Research Network, 2013Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:We have recently proposed an alternative approach to economic analysis, which we call Imperfect Knowledge Economics (IKE). Although IKE builds on the methodology of contemporary macroeconomics by modeling aggregate outcomes on the basis of mathematical representations of individual decision making, it jettisons models that generate sharp predictions. In this paper, we elaborate on and extend the arguments that led us to propose IKE. We show analytically that in order to avoid the fundamental epistemological flaws inherent in extant models, economists must stop short of fully prespecifying change. We also show how acknowledging the limits of their Knowledge may enable economists to shed new light on the basic features of observed time-series of market outcomes, such as fluctuations and risk in asset markets, which have confounded extant approaches for decades.Comments on this paper can be found at: http://ssrn.com/abstract=2209269
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The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory
Rethinking Expectations, 2013Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:This chapter examines the Imperfect Knowledge imperative in modern macroeconomics and finance theory. It argues that the Rational Expectations Hypothesis (REH) has nothing to do with how even minimally reasonable profit-seeking individuals forecast the future in real-world markets. It attributes REH's insurmountable epistemological difficulties and widespread empirical problems to a single, overarching premise that underpins contemporary macroeconomics and finance theory: nonroutine change is unimportant for understanding outcomes. It also suggests that contemporary behavioral finance models rest on the same core premise as their REH-based counterparts. Finally, it introduces an alternative approach to modeling individual behavior and aggregate outcomes: Imperfect Knowledge Economics, which opens macroeconomics and finance models to nonroutine change and the Imperfect Knowledge that it engenders.
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Macroeconomic Theory For a World of Imperfect Knowledge
Capitalism and Society, 2008Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:We have recently proposed an alternative approach to economic analysis, which we call Imperfect Knowledge Economics (IKE). Although IKE builds on the methodology of contemporary macroeconomics by modeling aggregate outcomes on the basis of mathematical representations of individual decision making, it jettisons models that generate sharp predictions. In this paper, we elaborate on and extend the arguments that led us to propose IKE. We show analytically that in order to avoid the fundamental epistemological flaws inherent in extant models, economists must stop short of fully prespecifying change. We also show how acknowledging the limits of their Knowledge may enable economists to shed new light on the basic features of observed time-series of market outcomes, such as fluctuations and risk in asset markets, which have confounded extant approaches for decades.
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A Resolution of the Purchasing Power Parity Puzzle: Imperfect Knowledge and Long Swings
SSRN Electronic Journal, 2008Co-Authors: Roman Frydman, Michael D. Goldberg, Søren Johansen, Katarina JuseliusAbstract:Asset prices undergo long swings that revolve around benchmark levels. In currency markets, fluctuations involve real exchange rates that are highly persistent and that move in near-parallel fashion with nominal rates. The inability to explain these two regularities with one model has been called the "Purchasing Power Parity puzzle". In this paper, we trace the puzzle to exchange rate modelers' use of the "Rational Expectations Hypothesis". We show that once Imperfect Knowledge is recognized, a monetary model is able to account for the puzzle, as well as other salient features of the data, including the long-swings behavior of exchange rates.
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Recognizing the Limits of Economists' Knowledge, from Imperfect Knowledge Economics: Exchange Rates and Risk
Introductory Chapters, 2007Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:Posing a major challenge to economic orthodoxy, Imperfect Knowledge Economics asserts that exact models of purposeful human behavior are beyond the reach of economic analysis. Roman Frydman and Michael Goldberg argue that the longstanding empirical failures of conventional economic models stem from their futile efforts to make exact predictions about the consequences of rational, self-interested behavior. Such predictions, based on mechanistic models of human behavior, disregard the importance of individual creativity and unforeseeable sociopolitical change. Scientific though these explanations may appear, they usually fail to predict how markets behave. And, the authors contend, recent behavioral models of the market are no less mechanistic than their conventional counterparts: they aim to generate exact predictions of "irrational" human behavior. Frydman and Goldberg offer a long-overdue response to the shortcomings of conventional economic models. Drawing attention to the inherent limits of economists' Knowledge, they introduce a new approach to economic analysis: Imperfect Knowledge Economics (IKE). IKE rejects exact quantitative predictions of individual decisions and market outcomes in favor of mathematical models that generate only qualitative predictions of economic change. Using the foreign exchange market as a testing ground for IKE, this book sheds new light on exchange-rate and risk-premium movements, which have confounded conventional models for decades. Offering a fresh way to think about markets and representing a potential turning point in economics, Imperfect Knowledge Economics will be essential reading for economists, policymakers, and professional investors.
Roman Frydman - One of the best experts on this subject based on the ideXlab platform.
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Macroeconomic Theory for a World of Imperfect Knowledge
Social Science Research Network, 2013Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:We have recently proposed an alternative approach to economic analysis, which we call Imperfect Knowledge Economics (IKE). Although IKE builds on the methodology of contemporary macroeconomics by modeling aggregate outcomes on the basis of mathematical representations of individual decision making, it jettisons models that generate sharp predictions. In this paper, we elaborate on and extend the arguments that led us to propose IKE. We show analytically that in order to avoid the fundamental epistemological flaws inherent in extant models, economists must stop short of fully prespecifying change. We also show how acknowledging the limits of their Knowledge may enable economists to shed new light on the basic features of observed time-series of market outcomes, such as fluctuations and risk in asset markets, which have confounded extant approaches for decades.Comments on this paper can be found at: http://ssrn.com/abstract=2209269
-
The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory
Rethinking Expectations, 2013Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:This chapter examines the Imperfect Knowledge imperative in modern macroeconomics and finance theory. It argues that the Rational Expectations Hypothesis (REH) has nothing to do with how even minimally reasonable profit-seeking individuals forecast the future in real-world markets. It attributes REH's insurmountable epistemological difficulties and widespread empirical problems to a single, overarching premise that underpins contemporary macroeconomics and finance theory: nonroutine change is unimportant for understanding outcomes. It also suggests that contemporary behavioral finance models rest on the same core premise as their REH-based counterparts. Finally, it introduces an alternative approach to modeling individual behavior and aggregate outcomes: Imperfect Knowledge Economics, which opens macroeconomics and finance models to nonroutine change and the Imperfect Knowledge that it engenders.
-
Macroeconomic Theory For a World of Imperfect Knowledge
Capitalism and Society, 2008Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:We have recently proposed an alternative approach to economic analysis, which we call Imperfect Knowledge Economics (IKE). Although IKE builds on the methodology of contemporary macroeconomics by modeling aggregate outcomes on the basis of mathematical representations of individual decision making, it jettisons models that generate sharp predictions. In this paper, we elaborate on and extend the arguments that led us to propose IKE. We show analytically that in order to avoid the fundamental epistemological flaws inherent in extant models, economists must stop short of fully prespecifying change. We also show how acknowledging the limits of their Knowledge may enable economists to shed new light on the basic features of observed time-series of market outcomes, such as fluctuations and risk in asset markets, which have confounded extant approaches for decades.
-
A Resolution of the Purchasing Power Parity Puzzle: Imperfect Knowledge and Long Swings
SSRN Electronic Journal, 2008Co-Authors: Roman Frydman, Michael D. Goldberg, Søren Johansen, Katarina JuseliusAbstract:Asset prices undergo long swings that revolve around benchmark levels. In currency markets, fluctuations involve real exchange rates that are highly persistent and that move in near-parallel fashion with nominal rates. The inability to explain these two regularities with one model has been called the "Purchasing Power Parity puzzle". In this paper, we trace the puzzle to exchange rate modelers' use of the "Rational Expectations Hypothesis". We show that once Imperfect Knowledge is recognized, a monetary model is able to account for the puzzle, as well as other salient features of the data, including the long-swings behavior of exchange rates.
-
Recognizing the Limits of Economists' Knowledge, from Imperfect Knowledge Economics: Exchange Rates and Risk
Introductory Chapters, 2007Co-Authors: Roman Frydman, Michael D. GoldbergAbstract:Posing a major challenge to economic orthodoxy, Imperfect Knowledge Economics asserts that exact models of purposeful human behavior are beyond the reach of economic analysis. Roman Frydman and Michael Goldberg argue that the longstanding empirical failures of conventional economic models stem from their futile efforts to make exact predictions about the consequences of rational, self-interested behavior. Such predictions, based on mechanistic models of human behavior, disregard the importance of individual creativity and unforeseeable sociopolitical change. Scientific though these explanations may appear, they usually fail to predict how markets behave. And, the authors contend, recent behavioral models of the market are no less mechanistic than their conventional counterparts: they aim to generate exact predictions of "irrational" human behavior. Frydman and Goldberg offer a long-overdue response to the shortcomings of conventional economic models. Drawing attention to the inherent limits of economists' Knowledge, they introduce a new approach to economic analysis: Imperfect Knowledge Economics (IKE). IKE rejects exact quantitative predictions of individual decisions and market outcomes in favor of mathematical models that generate only qualitative predictions of economic change. Using the foreign exchange market as a testing ground for IKE, this book sheds new light on exchange-rate and risk-premium movements, which have confounded conventional models for decades. Offering a fresh way to think about markets and representing a potential turning point in economics, Imperfect Knowledge Economics will be essential reading for economists, policymakers, and professional investors.
Andrew Walenstein - One of the best experts on this subject based on the ideXlab platform.
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EVALUATING THEORIES FOR MANAGING Imperfect Knowledge IN HUMAN-CENTRIC DATABASE REENGINEERING ENVIRONMENTS
International Journal of Software Engineering and Knowledge Engineering, 2002Co-Authors: Jens H Jahnke, Andrew WalensteinAbstract:Modernizing heavily evolved and poorly documented information systems is a central software engineering problem in our current IT industry. It is often necessary to reverse engineer the design documentation of such legacy systems. Several interactive CASE tools have been developed to support this human-intensive process. However, practical experience indicates that their applicability is limited because they do not adequately handle Imperfect Knowledge about legacy systems. In this paper, we investigate the applicability of several major theories of Imperfect Knowledge management in the area of soft computing and approximate reasoning. The theories are evaluated with respect to how well they meet requirements for generating effective human-centred reverse engineering environments. The requirements were elicited with help from practical case studies in the area of database reverse engineering. A particular theory called "possibilistic logic" was found to best meet these requirements most comprehensively. This evaluation highlights important challenges to the designers of Knowledge management techniques, and should help reverse engineering tool implementers select appropriate technologies.
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reverse engineering tools as media for Imperfect Knowledge
Working Conference on Reverse Engineering, 2000Co-Authors: Jens H Jahnke, Andrew WalensteinAbstract:Reverse engineering is an Imperfect process driven by Imperfect Knowledge. Most current reverse engineering tools do not adequately consider these inherent characteristics. They focus an representing precise, complete and consistent Knowledge and work towards enforcing predefined structures on the processes. According to our experience, this design paradigm seriously limits human-centred reverse engineering tools. An altogether different approach is to directly support the statement and subsequent resolution of Imperfections. Doing so requires the Imperfect Knowledge be represented and Imperfect procedures accommodated for. We argue that effective tools need to act as a manipulable medium for Imperfect Knowledge and, based on our experiences with a prototype, elaborate requirements for such tools.
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WCRE - Reverse engineering tools as media for Imperfect Knowledge
Proceedings Seventh Working Conference on Reverse Engineering, 1Co-Authors: Jens H Jahnke, Andrew WalensteinAbstract:Reverse engineering is an Imperfect process driven by Imperfect Knowledge. Most current reverse engineering tools do not adequately consider these inherent characteristics. They focus an representing precise, complete and consistent Knowledge and work towards enforcing predefined structures on the processes. According to our experience, this design paradigm seriously limits human-centred reverse engineering tools. An altogether different approach is to directly support the statement and subsequent resolution of Imperfections. Doing so requires the Imperfect Knowledge be represented and Imperfect procedures accommodated for. We argue that effective tools need to act as a manipulable medium for Imperfect Knowledge and, based on our experiences with a prototype, elaborate requirements for such tools.
