Policy Evaluation and Uncertainty About the Effects of Oil Prices on Economic Activity

• Authors: Francesca Rondina.
• BSE Working Paper: 522 | September 15
• Keywords: model uncertainty , robust policy , Bayesian model averaging , oil prices , minimax
• JEL codes: C52, E52, E58
• model uncertainty
• robust policy
• Bayesian model averaging
• oil prices
• minimax

This paper addresses the issue of policy evaluation in a context in which policymakers are uncertain about the e€ects of oil prices on economic performance. I consider models of the economy inspired by Solow (1980), Blanchard and Gali (2007), Kim and Loungani (1992) and Hamilton (1983, 2005), which incorporate di€erent assumptions on the channels through which oil prices have an impact on economic activity. I first study the characteristics of the model space and I analyze the likelihood of the di€erent specifcations. I show that the existence of plausible alternative representations of the economy forces the policy maker to face the problem of model uncertainty. Then, I use the Bayesian approach proposed by Brock, Durlauf and West (2003, 2007) and the minimax approach developed by Hansen and Sargent (2008) to integrate this form of uncertainty into policy evaluation. I find that, in the environment under analysis, the standard Taylor rule is out performed under a number of criteria by alternative simple rules in which policymakers introduce persistence in the policy instrument and respond to changes in the real price of oil.