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The Implications of Uncertainty for Monetary Policy

Author

Listed:
  • Geoffrey Shuetrim

    (Reserve Bank of Australia)

  • Christopher Thompson

    (Reserve Bank of Australia)

Abstract

In this paper we use a simple model of the Australian economy to empirically examine the consequences of parameter uncertainty for optimal monetary policy. Optimal policy responses are derived for a monetary authority that targets inflation and output stability. Parameter uncertainty is characterised by the estimated distribution of the model coefficient estimates. Learning is ruled out, so the monetary authority can commit to its ex ante policy response. We find that taking account of parameter uncertainty can recommend more, rather than less, activist use of the policy instrument. While we acknowledge that this finding is specific to the model specification, parameter estimates and the shocks analysed, the result does stand in contrast to the widely held belief that the generic implication of parameter uncertainty is more conservative policy.

Suggested Citation

  • Geoffrey Shuetrim & Christopher Thompson, 1999. "The Implications of Uncertainty for Monetary Policy," RBA Research Discussion Papers rdp1999-10, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp1999-10
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    References listed on IDEAS

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    Cited by:

    1. Guglielmo Caporale & Luca Onorante & Paolo Paesani, 2012. "Inflation and inflation uncertainty in the euro area," Empirical Economics, Springer, vol. 43(2), pages 597-615, October.
    2. Ulf Söderström, 2002. "Monetary Policy with Uncertain Parameters," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(1), pages 125-145, March.
    3. Adam Cagliarini & Alexandra Heath, 2000. "Monetary Policy-making in the Presence of Knightian Uncertainty," RBA Research Discussion Papers rdp2000-10, Reserve Bank of Australia.
    4. Ajax R. B. Moreira & Marco A. F. H. Cavalcanti, 2015. "Robustness and Stabilization Properties of Monetary Policy Rules in Brazil," Discussion Papers 0100, Instituto de Pesquisa Econômica Aplicada - IPEA.
    5. Adam Cagliarini & Guy Debelle, 2002. "The Effect of Uncertainty on Monetary Policy: How Good are the Brakes?," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 7, pages 167-196, Central Bank of Chile.
    6. Andrew Stone & Troy Wheatley & Louise Wilkinson, 2005. "A Small Model of the Australian Macroeconomy: An Update," RBA Research Discussion Papers rdp2005-11, Reserve Bank of Australia.
    7. Robert Tetlow & Peter von zur Muehlen, 2004. "Avoiding Nash Inflation: Bayesian and Robus Responses to Model Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(4), pages 869-899, October.
    8. Kirdan Lees, 2004. "Uncertainty and the open economy: a view through two different lenses," Econometric Society 2004 Australasian Meetings 235, Econometric Society.
    9. Marc-Alexandre Sénégas, 2002. "La politique monétaire face à l'incertitude : un survol méthodologique des contributions relatives à la zone euro," Revue d'Économie Financière, Programme National Persée, vol. 65(1), pages 177-200.
    10. Glenn D. Rudebusch, 2006. "Monetary Policy Inertia: Fact or Fiction?," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
    11. Guido Cazzavillan & Michael Donadelli, 2010. "Understanding the Global Demand Collapse: Empirical Analysis and Optimal Policy Response," Working Papers 2010_18, Department of Economics, University of Venice "Ca' Foscari".
    12. Ha, Yuong, 1999. "Uncertainty about Length of the Monetary Policy Transmission Lag: Implications for Monetary Policy," Working Paper Series 94, Sveriges Riksbank (Central Bank of Sweden).
    13. Michael Donadelli, 2015. "Uncertainty shocks and policymakers’ behavior: evidence from the subprime crisis era," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 42(4), pages 578-607, September.
    14. Rehab OSMAN, 2010. "SADC EPAs with the EU: the Right or a Blight Way for Development," EcoMod2010 259600127, EcoMod.
    15. Fatemeh Labafi Feriz & Saeed Samadi & khadijeh Nasrollahi & Rasul Bakhshi Dastjerdi, 2018. "Robust Discretionary Monetary Policy under Cost-Push Shock Uncertainty of Iran’s Economy," Iranian Economic Review (IER), Faculty of Economics,University of Tehran.Tehran,Iran, vol. 22(2), pages 503-526, Spring.
    16. Moessner, Richhild, 2005. "Optimal discretionary policy and uncertainty about inflation persistence," Working Paper Series 540, European Central Bank.
    17. Lansing, Kevin J. & Trehan, Bharat, 2003. "Forward-looking behavior and optimal discretionary monetary policy," Economics Letters, Elsevier, vol. 81(2), pages 249-256, November.
    18. Daniel Laskar, 2006. "Incertitude sur l'effet global ou sur les délais d'action de la politique économique : politique robuste et activisme," Working Papers halshs-00590542, HAL.
    19. Gert Peersman & Frank Smets, 1999. "The Taylor Rule: A Useful Monetary Policy Benchmark for the Euro Area?," International Finance, Wiley Blackwell, vol. 2(1), pages 85-116, April.
    20. Ben Martin, 1999. "Caution and gradualism in monetary policy under uncertainty," Bank of England working papers 105, Bank of England.
    21. Soderstrom, Ulf, 2002. " Monetary Policy with Uncertain Parameters," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(1), pages 125-145.
    22. 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.
    23. Benjamin Hunt & Peter Isard, 2003. "Some implications for monetary policy of uncertain exchange rate pass‐through," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 567-584, November.
    24. Richard Dennis, 2003. "Exploring the Role of the Real Exchange Rate in Australian Monetary Policy," The Economic Record, The Economic Society of Australia, vol. 79(244), pages 20-38, March.
    25. Simon Hall & Chris Salmon & Tony Yates & Nicoletta Batini, 1999. "Uncertainty and Simple Monetary Policy Rules - An illustration for the United Kingdom," Bank of England working papers 96, Bank of England.

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    More about this item

    Keywords

    optimal monetary policy; parameter uncertainty;

    JEL classification:

    • 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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