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Changes in GDP’s measurement error volatility and response of the monetary policy rate: Two approaches

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  • Julian A. Parra-Polania

    ()

  • Carmiña O. Vargas

    ()

Abstract

Using a stylized model in which output is measured with error, we derive the optimal policy response to the demand shock signal and to changes in the measurement error volatility from two different perspectives: the minimization of the expected loss (from which we derive the ‘standard’ policy) and the minimization of the maximum possible loss across all potential scenarios (from which we derive the ‘prudent’ or ‘robust’ policy). We find that (1) the prudent policymaker reacts more aggressively to the shock signal than the standard one and (2) while the standard policymaker always mitigates her reaction if the measurement error volatility rises, the prudent one may even increase her response if her risk aversion is very high. When we incorporate forward-looking expectations, the second result is preserved but, in this case, the prudent policymaker is less aggressive than the standard one in responding to the shock signal. ****** Usando un modelo estilizado en el que el producto se mide con error, determinamos la respuesta de política óptima a la señal del choque de demanda y a los cambios en la volatilidad del error de medición desde dos perspectivas diferentes: la minimización de la pérdida esperada (de la que derivamos la política “estándar†) y la minimización de la pérdida máxima en todos los escenarios posibles (de la que derivamos la política “prudente†o “robusta†). Observamos que: (1) el tomador de decisiones de política prudente reacciona de manera más agresiva a la señal de choque que el decisor estándar y (2) mientras que el decisor estándar siempre atenúa su reacción si aumenta la volatilidad del error de medición, el decisor prudente puede aumentar incluso su respuesta si su aversión al riesgo es muy alta. Cuando incorporamos las expectativas futuras, el segundo resultado se mantiene, pero, en este caso, el decisor prudente es menos agresivo que el estándar en su respuesta a la señal de choque.

Suggested Citation

  • Julian A. Parra-Polania & Carmiña O. Vargas, 2014. "Changes in GDP’s measurement error volatility and response of the monetary policy rate: Two approaches," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República - ESPE, vol. 32(75), pages 41-47, December.
  • Handle: RePEc:col:000107:012406
    DOI: 10.1016/j.espe.2014.08.002
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    References listed on IDEAS

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    1. van der Ploeg, Frederick, 2009. "Prudent monetary policy and prediction of the output gap," Journal of Macroeconomics, Elsevier, vol. 31(2), pages 217-230, June.
    2. Lars Peter Hansen & Thomas J. Sargent, 2007. "Introduction to Robustness," Introductory Chapters, in: Robustness, Princeton University Press.
    3. Bodenstein, Martin & Hebden, James & Nunes, Ricardo, 2012. "Imperfect credibility and the zero lower bound," Journal of Monetary Economics, Elsevier, vol. 59(2), pages 135-149.
    4. Gadi Barlevy, 2009. "Policymaking under uncertainty: Gradualism and robustness," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 33(Q II), pages 38-55.
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    More about this item

    Keywords

    Prudence; Robustness; Measurement error; Optimal monetary policy;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • 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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