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The Response of Monetary Policy to Uncertainty: Theory and Empirical Evidence for the US

Author

Listed:
  • Christopher Martin

    (Brunel University)

  • Costas Milas

    (Keele University, Centre for Economic Research and School of Economic and Management Studies)

Abstract

This paper developes a theoretical model to analyse the impact of uncertainty about the true state of the economy on monetary policy. The theoretical model is tested on US data since the early 1980s. Our estimates suggest that the effect of uncertainty on interest rates was most marked in 1983, when uncertainty increased interest rates by up to 140 basis points, in 1990-91, when uncertainty reduced interest rates by up to 80 basis points and in 1996-2001 when uncertainty reduced interest rates by up to 70 basis points over five years.

Suggested Citation

  • Christopher Martin & Costas Milas, 2005. "The Response of Monetary Policy to Uncertainty: Theory and Empirical Evidence for the US," Keele Economics Research Papers KERP 2006/15, Centre for Economic Research, Keele University, revised Aug 2006.
    • Handle: RePEc:kee:kerpuk:2006/15
    Note: We thank seminar audiences at Brunel, Cambridge and Loughborough Universities and at Cass Business School for their comments.
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    File URL: http://www.keele.ac.uk/depts/ec/wpapers/kerp0615.pdf
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    Keywords

    Monetary Policy; Uncertainty;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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