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Scenario discovery to address deep uncertainty in monetary policy

Working paper 818
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Published: 08 November 2024

By: Chamon Wieles Jan Kwakkel Willem L. Auping Jan Willem van den End

We analyse shock and parameter uncertainty in a Dynamic Stochastic General Equilibrium (DSGE) model by exploratory modelling and analysis (EMA). This method evaluates in a novel way the performance of monetary policy under deep uncertainty about the shock and model parameters. Scenarios are designed based on the outcomes of interest for the policymaker. We assess the performance of different policies on their objectives in the scenarios. This maps out the policy trade-offs and supports the central bank in making robust policy decisions. We find that in response to a negative supply shock, policies with low interest rate smoothing and a strong response to inflation most obviously contribute to price stability under deep uncertainty.

Keywords: Monetary policy; Scenarios; Exploratory modelling; Deep uncertainty
JEL codes E52; E58; G12

Working paper no. 818

818 - Scenario discovery to address deep uncertainty in monetary policy

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Research highlights

  • We apply exploratory modelling and analysis (EMA) to analyse shock and parameter uncertainty in a Dynamic Stochastic General Equilibrium (DSGE)
  • The outcomes show that negative supply shock scenarios in states with low price flexibility and high shock persistence most obviously impair the inflation and output gap objectives.
  • The EMA directed search method identifies monetary policy responses that are robust to future unknown states of the world.

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