Doubts about the model and optimal policy

No 2312, Discussion Papers from Centre for Macroeconomics (CFM)

Abstract: This paper analyzes optimal policy in setups where both the policymaker and the private sector have doubts about the probability model of uncertainty and form endogenous worstcase beliefs. There are two forces that shape optimal policy results: a) the manipulation of the endogenous beliefs of the private sector so that the forward-looking constraints that the policymaker is facing are relaxed, b) the discrepancy (if any) in pessimistic beliefs between a paternalistic policymaker and the private sector, which captures ultimately differences in welfare evaluation. I illustrate the methodology in an optimal fiscal policy problem and show that manipulation of beliefs materializes as an effort to make government debt cheaper through the endogenous beliefs of the household. This force may lead to either mitigation or amplification of the household’s pessimism, depending on the problem’s parameters. The policymaker’s relative pessimism determines whether paternalism reinforces or opposes the price manipulation incentives.

Keywords: Model uncertainty; ambiguity aversion; robustness; multiplier preferences; optimal policy design; managing expectations (search for similar items in EconPapers)
JEL-codes: D80 E52 E61 E62 H21 H63 (search for similar items in EconPapers)
Pages: 89 pages
Date: 2023-04
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.lse.ac.uk/CFM/assets/pdf/CFM-Discussio ... MDP2023-12-Paper.pdf (application/pdf)

Related works:
Journal Article: Doubts about the model and optimal policy (2023)
Working Paper: Doubts about the model and optimal policy (2023)
Working Paper: Doubts about the Model and Optimal Policy (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cfm:wpaper:2312

Access Statistics for this paper

More papers in Discussion Papers from Centre for Macroeconomics (CFM) Contact information at EDIRC.
Bibliographic data for series maintained by Helen Power ().