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Uncertainty about the length of the monetary policy transmission lag: implications for monetary policy

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Abstract

This paper examines implications for monetary policy of uncertainty about the length of the monetary policy transmission lag in a stochastic environment. Two key questions are asked. Firstly, which type of inflation-forecast-based rules work well when the central bank does not know the length of the monetary policy transmission lag? The results show that rules that are less aggressive and more forward looking are more robust. That is, the performance of these rules are least affected by lag uncertainty. However, it is still the case that relatively more aggressive and less forward looking rules will produce lower inflation variability. With any inflation forecasting model, policymakers must take a view on how quickly their actions impact on inflation. There will always be a significant degree of uncertainty surrounding this transmission lag such that a central bank is unlikely to get this right all the time. The second question asks, is it better to overestimate or underestimate this transmission lag? When the lag is overestimated (underestimated), the central bank behaves as if inflation is harder (easier) to control than it really is. The results show that a strategy of overestimating is superior to underestimating the lag. In fact, it may be even be a preferred strategy to knowing the true lag.

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File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2000/dp00_1.pdf
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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2000/01.

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Length: 27p
Date of creation: Feb 2000
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Handle: RePEc:nzb:nzbdps:2000/01

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  1. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  2. Isard, Peter & Laxton, Douglas & Eliasson, Ann-Charlotte, 2001. "Inflation targeting with NAIRU uncertainty and endogenous policy credibility," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 115-148, January.
  3. Geoffrey Shuetrim & Christopher Thompson, 1999. "The Implications of Uncertainty for Monetary Policy," RBA Research Discussion Papers rdp1999-10, Reserve Bank of Australia.
  4. Amano, Robert & Coletti, Don & Macklem, Tiff, 1999. "Monetary Rules When Economic Behaviour Changes," Working Papers 99-8, Bank of Canada.
  5. Alexei Onatski & James H. Stock, 1999. "Robust monetary policy under model uncertainty in a small model of the U.S. economy," Proceedings, Federal Reserve Bank of San Francisco.
  6. Aaron Drew & Ben Hunt, 1998. "The Forecasting and Policy System: stochastic simulations of the core model," Reserve Bank of New Zealand Discussion Paper Series G98/6, Reserve Bank of New Zealand.
  7. Caplin, Andrew & Leahy, John, 1996. "Monetary Policy as a Process of Search," American Economic Review, American Economic Association, vol. 86(4), pages 689-702, September.
  8. Mankiw, N. Gregory (ed.), 1997. "Monetary Policy," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226503097, September.
  9. Frankel, Jeffrey A & Rockett, Katharine E, 1988. "International Macroeconomic Policy Coordination When Policymakers Do Not Agree on the True Model," American Economic Review, American Economic Association, vol. 78(3), pages 318-40, June.
  10. Aaron Drew & Benjamin Hunt, 1999. "Efficient simple policy rules and the implications of potential output uncertainty," Reserve Bank of New Zealand Discussion Paper Series G99/5, Reserve Bank of New Zealand.
  11. Eileen Mauskopf & Jeffrey Fuhrer & Peter Tinsley, 1990. "The transmission channels of monetary policy: how have they changed?," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 985-1008.
  12. Ghosh, Atish R & Masson, Paul R, 1991. "Model Uncertainty, Learning, and the Gains from Coordination," American Economic Review, American Economic Association, vol. 81(3), pages 465-79, June.
  13. Paul Conway & Aaron Drew & Ben Hunt & Alasdair Scott, 1998. "Exchange rate effects and inflation targeting in a small open economy: a stochastic analysis using FPS," Reserve Bank of New Zealand Discussion Paper Series G99/4, Reserve Bank of New Zealand.
  14. David Gruen & John Romalis & Naveen Chandra, 1997. "The Lags of Monetary Policy," RBA Research Discussion Papers rdp9702, Reserve Bank of Australia.
  15. Andrew G Haldane, 1997. "Designing Inflation Targets," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
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Cited by:
  1. L Christopher Plantier & Dean Scrimgeour, 2002. "Estimating a Taylor Rule for New Zealand with a time-varying neutral real rate," Reserve Bank of New Zealand Discussion Paper Series DP2002/06, Reserve Bank of New Zealand.
  2. John C. Robertson, 2000. "Central bank forecasting: an international comparison," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 21-32.
  3. Paul Conway, 2000. "Monetary policy in an uncertain world," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 63, September.

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