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Monetary policy and uncertainty about the natural unemployment rate

  • Volker Wieland

This paper studies the optimal monetary policy in the presence of uncertainty about the natural rate and the short-run inflation-unemployment tradeoff. Two conflicting motives drive policy. In the static version of the model, uncertainty provides a motive for the policymaker to move cautiously. In the dynamic version, uncertainty motivates an element of experimentation. I find that the optimal policy that balances these motives typically still exhibits gradualism, i.e., is less aggressive than a policy that disregards parameter uncertainty. Exceptions occur when uncertainty is very high and inflation close to target.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 1998-22.

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Date of creation: 1998
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Handle: RePEc:fip:fedgfe:1998-22
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