Robust Estimation and Monetary Policy with Unobserved Structural Change

2004-11 | July 1, 2004

This paper considers the joint problem of model estimation and implementation of monetary policy in the face of uncertainty regarding the process of structural change in the economy. I model unobserved structural change through time variation in the natural rates of interest and unemployment. I show that certainty equivalent optimal policies perform poorly when there is model uncertainty about the natural rate processes. I then examine the properties of combined estimation methods and policy rules that are robust to this type of model uncertainty. I find that weighted averages of sample means perform well as estimators of natural rates. The optimal policy under uncertainty responds more aggressively to inflation and less so to the perceived unemployment gap than the certainty equivalent policy. This robust estimation/policy combination is highly effective at mitigating the effects of natural rate mismeasurement.

Article Citation

C. Williams, John. 2004. “Robust Estimation and Monetary Policy with Unobserved Structural Change,” Federal Reserve Bank of San Francisco Working Paper 2004-11. Available at

About the Author
John C. Williams served as President and Chief Executive Officer of the Federal Reserve Bank of San Francisco from March 1, 2011 to June 17, 2018. Dr. Williams was previously the executive vice president and director of research for the San Francisco bank, which he joined in 2002. He began his career in 1994 as an […] Learn more about John C. Williams