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Doubts about the model and optimal policy

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  • Karantounias, Anastasios G.
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 worst-case 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.

Suggested Citation

  • Karantounias, Anastasios G., 2023. "Doubts about the model and optimal policy," Journal of Economic Theory, Elsevier, vol. 210(C).
    • Handle: RePEc:eee:jetheo:v:210:y:2023:i:c:s002205312300039x
    DOI: 10.1016/j.jet.2023.105643
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Doubts about the Model and Optimal Policy
      by Christian Zimmermann in NEP-DGE blog on 2020-08-31 20:30:26

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    Cited by:

    1. Karantounias, Anastasios G., 2023. "Doubts about the model and optimal policy," Journal of Economic Theory, Elsevier, vol. 210(C).
    2. Yoosoon Chang & Fabio Gomez-Rodriguez & Christian Matthes, 2023. "The Influence of Fiscal and Monetary Policies on the Shape of the Yield Curve," CAEPR Working Papers 2023-008 Classification-E, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    3. Adam, Klaus & Woodford, Michael, 2021. "Robustly optimal monetary policy in a new Keynesian model with housing," Journal of Economic Theory, Elsevier, vol. 198(C).
    4. Cosmin L. Ilut & Martin Schneider, 2022. "Modeling Uncertainty as Ambiguity: a Review," NBER Working Papers 29915, National Bureau of Economic Research, Inc.
    5. Bennett, Federico & Montamat, Giselle & Roch, Francisco, 2023. "Robust optimal macroprudential policy," Journal of International Economics, Elsevier, vol. 141(C).
    6. , G., 2013. "Managing pessimistic expectations and fiscal policy," Theoretical Economics, Econometric Society, vol. 8(1), January.
    7. Thien Nguyen & Lukas Schmid & Howard Kung & Mariano Croce, 2012. "Fiscal Policies and Asset Prices," 2012 Meeting Papers 565, Society for Economic Dynamics.
    8. repec:bny:wpaper:0128 is not listed on IDEAS

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    More about this item

    Keywords

    Model uncertainty; Ambiguity aversion; Robustness; Multiplier preferences; Optimal policy design; Managing expectations;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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