hermann remsperger : macroeconomic risk and policy responses welcome address by professor hermann remsperger, member of the executive board of the deutsche bundesbank, at the 7th bundesbank spring conference " macroeconomic risk and policy responses ", berlin, 27 may 2005. * * * i have the pleasure of welcoming you to the 7th bundesbank spring conference which is organised jointly by the humboldt university berlin, the london - based centre for economic policy research and the deutsche bundesbank. the focus of this year ’ s conference is on “ macroeconomic risk and policy responses ”. risk and uncertainty are key elements of many decisions, above all those extending into the future. hence, the optimal response to risk has always been a topic of great interest to political, military and economic decision - makers. concern with this crucial issue is also reflected in the works of our great philosophers and writers. among those men of letters, a rather positive attitude towards taking risks seems to prevail. for example, the roman poet ovid claimed that “ both fortune and love befriend the bold ”. and friedrich von schiller wrote “ he that is overcautious will accomplish little ”. 1 now, in general, central bankers are not known for their boldness or love of risk, and i would claim that there are some good reasons for this. so – as a cautious central banker - i was very happy to find that at least the greek dramatist sophocles displayed a more balanced attitude towards risk when he warned that “ quick decisions are unsafe decisions ”. there is no need to explain to this audience that central banks face many forms of risk when taking monetary policy decisions. this was particularly true for the ecb when it started monetary policy in january 1999, but it is also true for central banks who act under more normal circumstances. alan greenspan has repeatedly made the point that : „... uncertainty is not just a pervasive feature of the monetary policy landscape ; it is the defining characteristic of that landscape “. 2 against this background, it comes as no surprise that the forms and consequences of risk and uncertainty for the optimal conduct of monetary policy have been a very active field of research in recent years. let me use this opportunity to render a very brief summary of what we have learned and what we have not learned - from this research so far. today it is generally recognised that maintaining price stability is the best contribution which monetary policy can make to

long - run macroeconomic welfare. therefore, most central banks – like the ecb and the bundesbank before it – are committed to the primary objective of achieving and maintaining price stability. in order to be able to assess the risks to price stability, monetary policy makers need models which represent the relevant structural relationships between the price level, the monetary policy instruments and other factors affecting price movements like changes in oil prices or exchange rates. however, the exact nature of these relationships is surrounded by a high degree of uncertainty. as a consequence, the question of which relationships are the “ relevant ” ones and which simplifications are “ adequate ” is – and will probably always be - a contentious one. one of the lessons that we have learned from recent research is that focusing on specification errors or parameter uncertainty in the neighbourhood of a particular reference model may dramatically understate the true degree of model uncertainty. it is therefore advisable for central banks to base their decisions on a broad range of models which reflect various assumptions regarding the transmission process. in fact, this is the approach which most central banks – and certainly the ecb – are already practising. “ wer gar zu viel bedenkt, wird wenig leisten ” aus : wilhelm tell. siehe greenspan, alan : monetary policy under uncertainty, rede auf dem symposium der federal reserve bank of kansas city, jackson hole, wyoming, 29. august 2003, sowie greenspan, alan : risks and uncertainty in monetary policy, rede auf dem treffen der american economic association, san diego, california, am 3. januar 2004. now, the question is which weights should policy makers attach to each of these competing models when assessing the risks to price stability? this is a very controversial issue. part of the academic literature assumes that policymakers or their staff form priors over the models and choose the approach which minimises average expected loss ( bayesian approach ). in contrast, the robust control approach assumes that policymakers are completely agnostic with respect to the probability that a specific model may represent the actual economy and thus choose the approach which minimises the maximum loss across all models ( minimax preferences ). in order to implement the bayesian approach, policymakers need to be able to attach a specific probability weight to each of the competing models. while this may be a very difficult task, the minimax approach also suffers from several drawbacks. 3 one fundamental problem