Book contents
- Frontmatter
- Contents
- Preface
- 1 Introduction
- 2 The theory of economic policy and the linear model
- 3 Optimal-policy design
- 4 Uncertainty and risk
- 5 Risk aversion, priorities and achievements
- 6 Non-linear optimal control
- 7 The linear rational-expectations model
- 8 Policy design for rational-expectations models
- 9 Non-cooperative, full-information dynamic games
- 10 Incomplete information, bargaining and social optima
- Notes
- References
- Index
4 - Uncertainty and risk
Published online by Cambridge University Press: 17 September 2009
- Frontmatter
- Contents
- Preface
- 1 Introduction
- 2 The theory of economic policy and the linear model
- 3 Optimal-policy design
- 4 Uncertainty and risk
- 5 Risk aversion, priorities and achievements
- 6 Non-linear optimal control
- 7 The linear rational-expectations model
- 8 Policy design for rational-expectations models
- 9 Non-cooperative, full-information dynamic games
- 10 Incomplete information, bargaining and social optima
- Notes
- References
- Index
Summary
INTRODUCTION
Reliability is obviously an important property for economic policies. Policy-makers can understand that economic policy-making requires a model, historical data, projections of exogenous events, and some kind of preference function – even if these quantities are specified informally rather than introduced into an explicit optimisation framework. But the extent of the uncertainty about future events, and about the accuracy of one's model as a representation of the economy, means that economic-policy formulation is seldom as straightforward as dynamic-optimisation procedures would suggest. The main difficulty with econometrically based policy recommendations is that they are not robust to shocks and that they seldom incorporate any real information about the form and extent of the risks faced. Indeed, the usual certainty-equivalent decision rules are invariant to risk. Thus, knowing that the above-mentioned four features of policy formulation are in fact uncertain, policy-makers often prefer to follow their own judgement. Moreover, policy-makers particularly dislike committing themselves to policies which they suspect may later need frequent and substantial revisions. If they can be convinced of the robustness of some particular alternative strategy, they may very well prefer to accept that strategy even if it promises fewer of the benefits offered potentially by other policies.
There is, therefore, a need to investigate whether the trade-off between a robust (or risk-sensitive) policy and one which is more ambitious is likely to be significant.
- Type
- Chapter
- Information
- Optimal Control, Expectations and Uncertainty , pp. 61 - 86Publisher: Cambridge University PressPrint publication year: 1989