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Should uncertain monetary policy-makers do less?

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  • Ben Martin
  • Chris Salmon
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    Abstract

    This paper examines the empirical importance of parameter uncertainty for monetary policy-making in the United Kingdom, using a method pioneered by Brian Sack of the US Federal Reserve. Using a VAR model of the UK economy and an assumed quadratic loss function for the policy-maker, an optimal interest rate rule is calculated first ignoring parameter uncertainty, then assuming that the parameter uncertainty is given by the estimated standard errors on the VAR coefficients. These rules are compared with the estimated interest rate equation from the VAR. The optimal rule accounting for parameter uncertainty results in a less aggressive path for official interest rates than when parameter uncertainty is ignored. However, the estimates of parameter uncertainty are not so large that the optimal rule matches all the characteristics of the actual path of official rates.

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    File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/1999/wp99.pdf
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    Bibliographic Info

    Paper provided by Bank of England in its series Bank of England working papers with number 99.

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    Date of creation: Aug 1999
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    Handle: RePEc:boe:boeewp:99

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    References

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    1. Volker Wieland, 1999. "Monetary policy, parameter uncertainty and optimal learning," Finance and Economics Discussion Series 1999-48, Board of Governors of the Federal Reserve System (U.S.).
    2. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
    3. Shamik Dhar & Darren Pain & Ryland Thomas, 2000. "A small structural empirical model of the UK monetary transmission mechanism," Bank of England working papers 113, Bank of England.
    4. Simon Hall & Chris Salmon & Tony Yates & Nicoletta Batini, 1999. "Uncertainty and Simple Monetary Policy Rules - An illustration for the United Kingdom," Bank of England working papers 96, Bank of England.
    5. David O. Cushman & Tao Zha, 1995. "Identifying monetary policy in a small open economy under flexible exchange rates," Working Paper 95-7, Federal Reserve Bank of Atlanta.
    6. Brian Sack, 1998. "Does the Fed act gradually? a VAR analysis," Finance and Economics Discussion Series 1998-17, Board of Governors of the Federal Reserve System (U.S.).
    7. Svensson, L-E-O, 1997. "Inflation Targeting : Some Extensions," Papers 625, Stockholm - International Economic Studies.
    8. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
    9. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
    10. Ben Martin, 1999. "Caution and gradualism in monetary policy under uncertainty," Bank of England working papers 105, Bank of England.
    11. Volker Wieland, 1996. "Learning by doing and the value of optimal experimentation," Finance and Economics Discussion Series 96-5, Board of Governors of the Federal Reserve System (U.S.).
    12. Brian Sack, 1998. "Uncertainty, learning, and gradual monetary policy," Finance and Economics Discussion Series 1998-34, Board of Governors of the Federal Reserve System (U.S.).
    13. Andrew Haldane, 1997. "Some Issues in Inflation Targeting," Bank of England working papers 74, Bank of England.
    14. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
    15. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
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    Cited by:
    1. Mayer, Eric, 2003. "The mechanics of a reasonably fitted quarterly New Keynesian macro model," W.E.P. - Würzburg Economic Papers 41, University of Würzburg, Chair for Monetary Policy and International Economics.
    2. Felipe Morandé L. & Mauricio Tejada G., 2008. "Sources of Uncertainty in Monetary Policy Conduct in Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 11(3), pages 45-80, December.

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