Optimal Monetary Policy with Real-time Signal Extraction from the Bond Market
AbstractMonetary policy is conducted in an environment of uncertainty. This paper sets up a model where the central bank uses real-time data from the bond market together with standard macroeconomic indicators to estimate the current state of the economy more efficiently, while taking into account that its own actions influence what it observes. The timeliness of bond market data allows for quicker responses of monetary policy to disturbances compared to the case when the central bank has to rely solely on collected aggregate data. The information content of the term structure creates a link between the bond market and the macroeconomy that is novel to the literature. To quantify the importance of the bond market as a source of information, the model is estimated on data for the United States and Australia using Bayesian methods. The empirical exercise suggests that there is some information in the US term structure that helps the Federal Reserve to identify shocks to the economy on a timely basis. Australian bond prices seem to be less informative than their US counterparts, perhaps because Australia is a relatively small and open economy.
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Bibliographic InfoPaper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2006-05.
Date of creation: Jun 2006
Date of revision:
Find related papers by JEL classification:
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-07-09 (All new papers)
- NEP-CBA-2006-07-09 (Central Banking)
- NEP-FMK-2006-07-09 (Financial Markets)
- NEP-MAC-2006-07-09 (Macroeconomics)
- NEP-MON-2006-07-09 (Monetary Economics)
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- Timothy Kam & Kirdan Lees & Philip Liu, 2006.
"Uncovering The Hit-List For Small Inflation Targeters: A Bayesian Structural Analysis,"
ANU Working Papers in Economics and Econometrics
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