Estimating an optimal macroeconomic uncertainty index for Australia

ABSTRACT

In this article, an optimal macroeconomic uncertainty index is constructed for the Australian economy. This index is derived from a small structural macroeconomic model. The structural model is first estimated using GMM to extract the parameter estimates, which are then used to initialize maximum likelihood techniques in order to obtain the optimal coefficient values for the relevant variables. The relevant variables are then weighted by the obtained optimal coefficients and, finally, are aggregated to produce the optimal macroeconomic uncertainty index for Australian economy. The empirical results show that the uncertainty index constructed is a good indicator of the optimal economic conditions in Australia, providing a useful tool to assist the Reserve Bank of Australia in its decision-making process.

KEYWORDS:

• Optimal uncertatiny index
• central bank
• GMM
• optimization algorithm

JEL CLASSIFICATION:

• C36
• C61
• E58.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ For more on the expected utility hypothesis, see von Neumann and Morgenstern (1947), Bernoulli (1954), Schoemaker (1982) and Camerer and Weber (1992). For more on the subjective expected utility hypothesis, see Savage (1954) and Enç (1998).

² For more details on certainty equivalence, see Svensson and Woodford (2003).

³ For more information about this structural model, see Gan (2014).