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

In: Monetary Policy: Rules and Transmission Mechanisms

  • Adam Cagliarini

    (Reserve Bank of Australia)

  • Guy Debelle

    (Reserve Bank of Australia)

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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This chapter was published in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Monetary Policy: Rules and Transmission Mechanisms, , chapter 7, pages 167-196, 2002.
This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v04c07pp167-196.
Handle: RePEc:chb:bcchsb:v04c07pp167-196
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  1. 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.
  2. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  3. repec:dgr:kubcen:199971 is not listed on IDEAS
  4. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  5. Marvin Goodfriend, 1986. "Interest rate smoothing and price level trend-stationarity," Working Paper 86-04, Federal Reserve Bank of Richmond.
  6. 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.
  7. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
  8. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  9. N. Gregory Mankiw, 1987. "The Optimal Collection of Seigniorage: Theory and Evidence," NBER Working Papers 2270, National Bureau of Economic Research, Inc.
  10. 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.), issue Jan, pages 1-19.
  11. Geoffrey Shuetrim & Christopher Thompson, 1999. "The Implications of Uncertainty for Monetary Policy," RBA Research Discussion Papers rdp1999-10, Reserve Bank of Australia.
  12. 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 1999-71, Tilburg University, Center for Economic Research.
  13. 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.
  14. Barro, Robert J., 1989. "Interest-rate targeting," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 3-30, January.
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