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The Implications of Uncertainty for Monetary Policy

  • Geoffrey Shuetrim
  • Christopher Thompson

This paper uses 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. For certain shocks, taking account of parameter uncertainty can recommend more, rather than less, activist use of the policy instrument. While this finding is specific to the model specification, parameter estimates and the shocks analysed, it contrasts with the widely held belief that the generic implication of parameter uncertainty is more conservative policy. Copyright 2003. The Economic Society of Australia.

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Article provided by The Economic Society of Australia in its journal The Economic Record.

Volume (Year): 79 (2003)
Issue (Month): 246 (09)
Pages: 370-379

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Handle: RePEc:bla:ecorec:v:79:y:2003:i:246:p:370-379
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  1. Jeroen J.M. Kremers & Neil R. Ericsson & Juan J. Dolado, 1992. "The power of cointegration tests," International Finance Discussion Papers 431, Board of Governors of the Federal Reserve System (U.S.).
  2. 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.
  3. Philip Lowe, 1997. "Introduction to Monetary Policy and Inflation Targeting," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  4. Clements, Michael P & Hendry, David F, 1996. "Intercept Corrections and Structural Change," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(5), pages 475-94, Sept.-Oct.
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