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Monetary policy and data uncertainty

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  • Jarkko Jääskelä
  • Tony Yates

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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Bibliographic Info

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

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Date of creation: Nov 2005
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Handle: RePEc:boe:boeewp:281

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References

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  1. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond.
  2. Brian Sack & Volker Wieland, 1999. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Finance and Economics Discussion Series 1999-39, Board of Governors of the Federal Reserve System (U.S.).
  3. 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.
  4. Athanasios Orphanides & John C. Williams, 2003. "Robust monetary policy rules with unknown natural rates," Finance and Economics Discussion Series 2003-11, Board of Governors of the Federal Reserve System (U.S.).
  5. Yates, Tony & Richard Harrison & George Kapetanios, 2003. "Forecasting with measurement errors in dynamic models," Royal Economic Society Annual Conference 2003 225, Royal Economic Society.
  6. Eric Swanson, 2000. "On Signal Extraction and Non-Certainty-Equivalence in Optimal Monetary Policy Rules," Econometric Society World Congress 2000 Contributed Papers 1085, Econometric Society.
  7. Roberts, John M., 1997. "Is inflation sticky?," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 173-196, July.
  8. 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.
  9. 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, School of Economics and Finance.
  10. Glenn D. Rudebusch, 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 2000-03, Federal Reserve Bank of San Francisco.
  11. Frank Smets, 2002. "Output gap uncertainty: Does it matter for the Taylor rule?," Empirical Economics, Springer, vol. 27(1), pages 113-129.
  12. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 861-886, October.
  13. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
  14. 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.
  15. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  16. 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.
  17. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
  18. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
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Cited by:
  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.

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