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Monetary policy and data uncertainty

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Jarkko Jääskelä
Tony Yates

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Abstract

One of the problems facing policymakers is that recent releases of data are liable to subsequent revisions. This paper discusses how to deal with this, and is in two parts. In the normative part of the paper, we study the design of monetary policy rules in a model that has the feature that data uncertainty varies according to the vintage. We show how coefficients on lagged variables in optimised simple rules for monetary policy increase as the relative measurement error in early vintages of data increases. We also explore scenarios when policymakers are uncertain by how much measurement error in new data exceeds that in old data. An optimal policy can then be one in which it is better to assume that the ratio of measurement error in new compared to old data is larger, rather than smaller. In the positive part of the paper, we show that the response of monetary policy to vintage varying data uncertainty may generate evidence of apparent interest rate smoothing in interest rate reaction functions: but we suggest that it may not generate enough to account for what has been observed in the data.

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Paper provided by Bank of England in its series Bank of England working papers with number 281.

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  1. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September. [Downloadable!] (restricted)
  2. Frank Smets, 2002. "Output gap uncertainty: Does it matter for the Taylor rule?," Empirical Economics, Springer, vol. 27(1), pages 113-129. [Downloadable!] (restricted)
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  3. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Papers in Applied Economic Theory 2003-01, Federal Reserve Bank of San Francisco. [Downloadable!]
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  4. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November. [Downloadable!] (restricted)
  5. Eric T. Swanson, 2000. "On signal extraction and non-certainty-equivalence in optimal monetary policy rules," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
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  6. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September. [Downloadable!] (restricted)
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  7. Bennett T. McCallum & Edward Nelson, 2000. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141. [Downloadable!] (restricted)
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  9. Richard Harrison & George Kapetanios & Tony Yates, 2004. "Forecasting with Measurement Errors in Dynamic Models," Working Papers 521, Queen Mary, University of London, Department of Economics. [Downloadable!]
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  10. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Blackwell Publishing, vol. 70(4), pages 861-886, October. [Downloadable!] (restricted)
  11. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January. [Downloadable!] (restricted)
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  12. Glenn D. Rudebusch, 2002. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Economic Journal, Royal Economic Society, vol. 112(479), pages 402-432, April. [Downloadable!] (restricted)
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  13. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June. [Downloadable!] (restricted)
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  14. George Kapetanios & Tony Yates, 2004. "Estimating Time-Variation in Measurement Error from Data Revisions: An Application to Forecasting in Dynamic Models," Working Papers 520, Queen Mary, University of London, Department of Economics. [Downloadable!]
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  15. Roberts, John M., 1997. "Is inflation sticky?," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 173-196, July. [Downloadable!] (restricted)
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  16. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228. [Downloadable!] (restricted)
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  17. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August. [Downloadable!] (restricted)
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  1. Carlo Altavilla & Matteo Ciccarelli, 2008. "Inflation models, optimal monetary policy and uncertain unemployment dynamics: Evidence from the US and the euro area," Discussion Papers 8_2008, D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy. [Downloadable!]
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