Is The Fed Too Timid? Monetary Policy In An Uncertain World

Estimates of the Taylor rule using historical data from the past decade or two suggest that monetary policy in the U.S. can be characterized as having reacted in a moderate fashion to output and inflation gaps. In contrast, the parameters of optimal Taylor rules derived using empirical models of the economy often recommend much more vigorous policy responses. This paper attempts to match the historical policy rule with an optimal policy rule by incorporating uncertainty into the derivation of the optimal rule and by examining plausible variations in the policymaker's model and preferences. © 2001 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology