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The Effect of Uncertainty on Monetary Policy: How Good are the Brakes?

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  • Adam Cagliarini
  • Guy Debelle

Abstract

In practice, monetary policy changes tend to produce a smooth path for interest rates while the path of policy interest rates generated by models is often considerably more variable. This paper investigates whether the inclusion of uncertainty can help reconcile the theory to the practice. It shows that parameter uncertainty does not induce much smoothness when its effects are directly incorporated into a model. Uncertainty about the interest sensitivity of output can increase the smoothness of optimal policy in a model, but the path of policy interest rates generated is still considerably more variable than that observed in practice.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 74.

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Date of creation: Jun 2000
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Handle: RePEc:chb:bcchwp:74

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  1. Marvin Goodfriend, 1986. "Interest rate smoothing and price level trend-stationarity," Working Paper 86-04, Federal Reserve Bank of Richmond.
  2. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
  3. Eijffinger, Sylvester C W & Schaling, Eric & Verhagen, Willem, 1999. "A Theory of Interest Rate Stepping: Inflation Targeting in a Dynamic Menu Cost Model," CEPR Discussion Papers 2168, C.E.P.R. Discussion Papers.
  4. N. Gregory Mankiw, 1988. "The Optimal Collection of Seigniorage: Theory and Evidence," NBER Working Papers 2270, National Bureau of Economic Research, Inc.
  5. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  6. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  7. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  8. Onatski, Alexei & Stock, James H., 2002. "Robust Monetary Policy Under Model Uncertainty In A Small Model Of The U.S. Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 85-110, February.
  9. David Reifschneider & Robert Tetlow & John Williams, 1999. "Aggregate disturbances, monetary policy, and the macroeconomy: the FRB/US perspective," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-19.
  10. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
  11. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  12. Geoffrey Shuetrim & Christopher Thompson, 1999. "The Implications of Uncertainty for Monetary Policy," RBA Research Discussion Papers rdp1999-10, Reserve Bank of Australia.
  13. Barro, Robert J., 1989. "Interest-rate targeting," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 3-30, January.
  14. 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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