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Should central banks be more aggressive?

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  • Söderström, Ulf

    () (Research Department, Central Bank of Sweden)

Abstract

Simple models of monetary policy often imply optimal policy behavior that is considerably more aggressive than what is commonly observed. This paper argues that such counterfactual implications are due to model restrictions and a failure to account for multiplicative parameter uncertainty, rather than to policymakers being too cautious in their implementation of policy. Comparing a restricted and an unrestricted version of the same empirical model, the unrestricted version leads to less volatility in optimal policy, and, taking parameter uncertainty into account, to policy paths very close to actual Federal Reserve policy.

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Bibliographic Info

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 84.

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Length: 31 pages
Date of creation: 01 May 1999
Date of revision:
Handle: RePEc:hhs:rbnkwp:0084

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Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Phone: 08 - 787 00 00
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Web page: http://www.riksbank.com/
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Keywords: Optimal monetary policy; parameter uncertainty; interest rate smoothing;

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References

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  1. Stanley Fischer, 1996. "Why are central banks pursuing long-run price stability?," Proceedings, Federal Reserve Bank of Kansas City, pages 7-34.
  2. Eric Ghysels & Norman R. Swanson & Myles Callan, 2002. "Monetary Policy Rules with Model and Data Uncertainty," Southern Economic Journal, Southern Economic Association, vol. 69(2), pages 239-265, October.
  3. Sims, Christopher A, 1998. "Comment on Glenn Rudebusch's "Do Measures of Monetary Policy in a VAR Make Sense?"," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 933-41, November.
  4. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," CFS Working Paper Series 2003/13, Center for Financial Studies (CFS).
  5. Svensson, Lars E.O. & Rudebusch , Glenn, 1998. "Policy Rules for Inflation Targeting," Seminar Papers 637, Stockholm University, Institute for International Economic Studies.
  6. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  7. Jeff Fuhrer & Brian Madigan, 1994. "Monetary policy when interest rates are bounded at zero," Working Papers in Applied Economic Theory 94-06, Federal Reserve Bank of San Francisco.
  8. Ben S. Bernanke & Ilian Mihov, 1998. "Measuring Monetary Policy," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 869-902, August.
  9. Stephen G. Cecchetti, 1998. "Policy rules and targets: framing the central banker's problem," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 1-14.
  10. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
  11. Wieland, Volker, 2003. "Monetary Policy and Uncertainty about the Natural Unemployment Rate," CEPR Discussion Papers 3811, C.E.P.R. Discussion Papers.
  12. Charles Goodhart, 1998. "Central Bankers and Uncertainty," FMG Special Papers sp106, Financial Markets Group.
  13. 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.).
  14. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
  15. Goodfriend, Marvin, 1987. "Interest rate smoothing and price level trend-stationarity," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 335-348, May.
  16. Olivier Blanchard & Lawrence F. Katz, 1997. "What We Know and Do Not Know about the Natural Rate of Unemployment," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 51-72, Winter.
  17. Arturo Extrella & Jeffrey C. Fuhrer, 1998. "Dynamic inconsistencies: counterfactual implications of a class of rational expectations models," Working Papers 98-5, Federal Reserve Bank of Boston.
  18. Jeffrey C. Fuhrer, 1995. "The Phillips curve is alive and well," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 41-56.
  19. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  20. Eijffinger, Sylvester C W & Schaling, Eric & Verhagen, Willem, 2000. "The Term Structure of Interest Rates and Inflation Forecast Targeting," CEPR Discussion Papers 2375, C.E.P.R. Discussion Papers.
  21. Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies.
  22. Athanasios Orphanides & Volker Wieland, 1998. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," Finance and Economics Discussion Series 1998-35, Board of Governors of the Federal Reserve System (U.S.).
  23. Ellingsen, Tore & Söderström, Ulf, 1998. "Monetary Policy and Market Interest Rates," Working Paper Series in Economics and Finance 242, Stockholm School of Economics, revised 08 Mar 1999.
  24. McCallum, Bennett T., 1993. "Discretion versus policy rules in practice: two critical points : A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 215-220, December.
  25. 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.
  26. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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Citations

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Cited by:
  1. Glenn D. Rudebusch, 2005. "Monetary policy inertia: fact or fiction?," Working Papers in Applied Economic Theory 2005-19, Federal Reserve Bank of San Francisco.
  2. Svensson, Lars E. O., 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Working Paper Series 91, Sveriges Riksbank (Central Bank of Sweden).
  3. Rudebusch, Glenn D. & Svensson, Lars E. O., 1999. "Eurosystem Monetary Targeting: Lessons from U.S. Data," Working Paper Series 92, Sveriges Riksbank (Central Bank of Sweden).
  4. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 911-949, June.
  5. Gino Cateau, 2005. "Monetary Policy under Model and Data-Parameter Uncertainty," Working Papers 05-6, Bank of Canada.
  6. Nessen, Marianne, 2002. "Targeting inflation over the short, medium and long term," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 313-329, September.
  7. Efrem Castelnuovo, 2003. "Squeezing the Interest Rate Smoothing Weight with a Hybrid Expectations Model," Working Papers 2003.6, Fondazione Eni Enrico Mattei.
  8. Efrem Castelnuovo, 2003. "Taylor Rules and Interest Rate Smoothing in the US and EMU," Macroeconomics 0303002, EconWPA.
  9. Troy Davig & Jeffrey R. Gerlach, 2006. "State-Dependent Stock Market Reactions to Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
  10. Carlo A. Favero, . "Parameters´ Instability, Model Uncertainty and Optimal Monetary Policy," Working Papers 196, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.

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