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Should uncertain monetary policy-makers do less?

  • Ben Martin
  • Chris Salmon

This paper examines the empirical importance of parameter uncertainty for monetary policy-making in the United Kingdom, using a method pioneered by Brian Sack of the US Federal Reserve. Using a VAR model of the UK economy and an assumed quadratic loss function for the policy-maker, an optimal interest rate rule is calculated first ignoring parameter uncertainty, then assuming that the parameter uncertainty is given by the estimated standard errors on the VAR coefficients. These rules are compared with the estimated interest rate equation from the VAR. The optimal rule accounting for parameter uncertainty results in a less aggressive path for official interest rates than when parameter uncertainty is ignored. However, the estimates of parameter uncertainty are not so large that the optimal rule matches all the characteristics of the actual path of official rates.

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File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/1999/wp99.pdf
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Paper provided by Bank of England in its series Bank of England working papers with number 99.

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Date of creation: Aug 1999
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Handle: RePEc:boe:boeewp:99
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  1. Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies.
  2. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  3. Wieland, Volker, 2000. "Learning by doing and the value of optimal experimentation," Journal of Economic Dynamics and Control, Elsevier, vol. 24(4), pages 501-534, April.
  4. Wieland, Volker, 2000. "Monetary policy, parameter uncertainty and optimal learning," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 199-228, August.
  5. Svensson, Lars E O, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," CEPR Discussion Papers 1511, C.E.P.R. Discussion Papers.
  6. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
  7. Cushman, David O. & Zha, Tao, 1997. "Identifying monetary policy in a small open economy under flexible exchange rates," Journal of Monetary Economics, Elsevier, vol. 39(3), pages 433-448, August.
  8. Ben Martin, 1999. "Caution and gradualism in monetary policy under uncertainty," Bank of England working papers 105, Bank of England.
  9. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  10. Brian Sack, 1998. "Uncertainty, learning, and gradual monetary policy," Finance and Economics Discussion Series 1998-34, Board of Governors of the Federal Reserve System (U.S.).
  11. Brian Sack, 1998. "Does the Fed act gradually? a VAR analysis," Finance and Economics Discussion Series 1998-17, Board of Governors of the Federal Reserve System (U.S.).
  12. Andrew Haldane, 1997. "Some Issues in Inflation Targeting," Bank of England working papers 74, Bank of England.
  13. Simon Hall & Chris Salmon & Tony Yates & Nicoletta Batini, 1999. "Uncertainty and Simple Monetary Policy Rules - An illustration for the United Kingdom," Bank of England working papers 96, Bank of England.
  14. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  15. Shamik Dhar & Darren Pain & Ryland Thomas, 2000. "A small structural empirical model of the UK monetary transmission mechanism," Bank of England working papers 113, Bank of England.
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