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The Effect of Uncertainty on Monetary Policy: How Good are the Brakes?

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  • Guy Debelle

    (Reserve Bank of Australia)

  • Adam Cagliarini

    (Reserve Bank of Australia)

Abstract

In practice, monetary policy changes tend to produce a smooth path for interest rates while the path of policy interest rates generated by models is often considerably more variable. This paper investigates whether the inclusion of uncertainty can help reconcile the theory to the practice. It shows that parameter uncertainty does not induce much smoothness when its effects are directly incorporated into a model. Uncertainty about the interest sensitivity of output can increase the smoothness of optimal policy in a model, but the path of policy interest rates generated is still considerably more variable than that observed in practice.

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2000-07.

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Date of creation: Oct 2000
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Handle: RePEc:rba:rbardp:rdp2000-07

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

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  1. Geoffrey Shuetrim & Christopher Thompson, 1999. "The Implications of Uncertainty for Monetary Policy," RBA Research Discussion Papers, Reserve Bank of Australia rdp1999-10, Reserve Bank of Australia.
  2. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
  3. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  4. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  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, Federal Reserve Bank of San Francisco.
  6. Barro, Robert J., 1989. "Interest-rate targeting," Journal of Monetary Economics, Elsevier, Elsevier, vol. 23(1), pages 3-30, January.
  7. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1998-50, Board of Governors of the Federal Reserve System (U.S.).
  8. Goodfriend, Marvin, 1987. "Interest rate smoothing and price level trend-stationarity," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(3), pages 335-348, May.
  9. Mankiw, N. Gregory, 1987. "The optimal collection of seigniorage : Theory and evidence," Journal of Monetary Economics, Elsevier, Elsevier, vol. 20(2), pages 327-341, September.
  10. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  11. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 46(1), pages 229-256, August.
  12. David Reifschneider & Robert Tetlow & John Williams, 1999. "Aggregate disturbances, monetary policy, and the macroeconomy: the FRB/US perspective," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-19.
  13. Eijffinger, S.C.W. & Schaling, E. & Verhagen, W.H., 1999. "A Theory of Interest Rate Stepping: Inflation Targeting in a Dynamic Menu Cost Model," Discussion Paper, Tilburg University, Center for Economic Research 1999-71, Tilburg University, Center for Economic Research.
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