Robust control and filtering of forward-looking models

Abstract

This paper shows how to compute robust Ramsey (aka Stackelberg) plans for linear models with forward looking private agents. We formulate a Bellman equation for the robust plan. We describe robust filtering for when some of the forcing variables (like potential GDP or trend growth) are not observed, and how the decision problem interacts with the filtering problem. We use a `new synthesis' macro model of Woodford as an example. 1. Introduction Milton Friedman expressed an enduring concern when he recommended that designers of macroeconomic policy rules acknowledge model uncertainty. His style of analysis revealed that he meant a kind of model uncertainty that could not be formalized in terms of objective or subjective probability distributions over models. For despite his willingness to use Savage's (1954) axioms in other work (see Friedman and Savage (1948)), he declined to use them in his writings on monetary policy. Instead Friedman indicated that he knew too little about the...

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