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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
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Keywords: Optimal monetary policy; parameter uncertainty; interest rate smoothing;

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References

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  1. Charles Goodhart, 1998. "Central Bankers and Uncertainty," FMG Special Papers sp106, Financial Markets Group.
  2. Wieland, Volker, 2003. "Monetary Policy and Uncertainty about the Natural Unemployment Rate," CFS Working Paper Series 2003/05, Center for Financial Studies (CFS).
  3. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring Monetary Policy," NBER Working Papers 5145, National Bureau of Economic Research, Inc.
  4. Eijffinger, S.C.W. & Schaling, E. & Verhagen, W.H., 1998. "The Term Structure of Interest Rates and Inflation Forecast Targeting," Discussion Paper 1998-85, Tilburg University, Center for Economic Research.
  5. 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.
  6. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," Working Paper Series 0231, European Central Bank.
  7. Stanley Fischer, 1996. "Why are central banks pursuing long-run price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 7-34.
  8. Myles Callan & Eric Ghysels & Norman R. Swanson, 1998. "Monetary Policy Rules with Model and Data Uncertainty," CIRANO Working Papers 98s-40, CIRANO.
  9. Marvin Goodfriend, 1987. "Interest rate smoothing and price level trend-stationarity," Working Paper 87-03, Federal Reserve Bank of Richmond.
  10. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  11. 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.
  12. 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.
  13. Lars E. O. Svensson, 1997. "Inflation Targeting: Some Extensions," NBER Working Papers 5962, National Bureau of Economic Research, Inc.
  14. 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.).
  15. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
  16. Olivier Blanchard & Lawrence F. Katz, 1996. "What We Know and Do Not Know About the Natural Rate of Unemployment," NBER Working Papers 5822, National Bureau of Economic Research, Inc.
  17. Jeffrey C. Fuhrer & Brian F. Madigan, 1997. "Monetary Policy When Interest Rates Are Bounded At Zero," The Review of Economics and Statistics, MIT Press, vol. 79(4), pages 573-585, November.
  18. 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.
  19. 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.
  20. 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.
  21. 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.
  22. 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.
  23. 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.
  24. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  25. 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.).
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Citations

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Cited by:
  1. 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.
  2. Gino Cateau, 2005. "Monetary Policy under Model and Data-Parameter Uncertainty," Working Papers 05-6, Bank of Canada.
  3. Rudebusch, Glenn D. & Svensson, Lars E. O., 2002. "Eurosystem monetary targeting: Lessons from U.S. data," European Economic Review, Elsevier, vol. 46(3), pages 417-442, March.
  4. Efrem Castelnuovo, 2003. "Squeezing the Interest Rate Smoothing Weight with a Hybrid Expectations Model," Working Papers 2003.6, Fondazione Eni Enrico Mattei.
  5. Glenn D. Rudebusch, 2005. "Monetary policy inertia: fact or fiction?," Working Paper Series 2005-19, Federal Reserve Bank of San Francisco.
  6. Lars E.O. Svensson, 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," NBER Working Papers 7276, National Bureau of Economic Research, Inc.
  7. 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.
  8. Nessen, Marianne, 2002. "Targeting inflation over the short, medium and long term," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 313-329, September.
  9. Efrem Castelnuovo, 2003. "Taylor Rules and Interest Rate Smoothing in the US and EMU," Macroeconomics 0303002, EconWPA.
  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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