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Dynamics of Monetary Policy Uncertainty and the Impact on the Macroeconomy

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  • Nicholas Herro

    ()
    (University of Wisconsin La Crosse)

  • James Murray

    ()
    (University of Wisconsin - La Crosse)

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    Abstract

    A large literature lauds the benefits of central bank transparency and credibility, but when a central bank like the U.S. Federal Reserve has a dual mandate, is not specific to the extent it targets employment versus price stability, and is not specific to the magnitude interest rates should change in response to these targets, market participants must depend largely on past data to form expectations about monetary policy. We suppose market participants estimate a Taylor-like regression equation to understand the conduct of monetary policy, which likely guides their short-run and long-run expectations. When the Federal Reserve's actions deviate from its historical targets for macroeconomic variables, an environment of greater uncertainty may be the result. We quantify this degree of uncertainty by measuring and aggregating recent deviations of the federal funds rate from econometric forecasts predicted by constant gain learning. We incorporate this measure of uncertainty into a VAR model with ARCH shocks to measure the effect monetary policy uncertainty has on inflation, output growth, unemployment, and the volatility of these variables. We find that a higher degree of uncertainty regarding monetary policy is associated with greater volatility of inflation and unemployment.

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    Bibliographic Info

    Article provided by AccessEcon in its journal Economics Bulletin.

    Volume (Year): 33 (2013)
    Issue (Month): 1 ()
    Pages: 257-270

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    Handle: RePEc:ebl:ecbull:eb-11-00249

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    Related research

    Keywords: Uncertainty; learning; volatility; Taylor rule; vector autoregression; ARCH;

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    References

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    1. Athanasios Orphanides, 2003. "Historical monetary policy analysis and the Taylor rule," Finance and Economics Discussion Series 2003-36, Board of Governors of the Federal Reserve System (U.S.).
    2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
    3. Fountas, Stilianos & Karanasos,Menelaos, 2001. "Inflation and Output Growth Uncertainty and their Relationship with Inflation and Output Growth," Working Papers 0053, National University of Ireland Galway, Department of Economics, revised 2001.
    4. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
    5. Katerina Smídková & Viktor Kotlán & David Navrátil & Ales Bulir, 2008. "Inflation Targeting and Communication: It Pays Off to Read Inflation Reports," IMF Working Papers 08/234, International Monetary Fund.
    6. Kevin B. Grier & �lan T. Henry & Nilss Olekalns & Kalvinder Shields, 2004. "The asymmetric effects of uncertainty on inflation and output growth," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 19(5), pages 551-565.
    7. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
    8. Stephen G. Cecchetti & Stefan Krause, 2002. "Central bank structure, policy efficiency, and macroeconomic performance: exploring empirical relationships," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 47-60.
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