IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

On signal extraction and non-certainty-equivalence in optimal monetary policy rules

  • Eric T. Swanson

A standard result in the literature on monetary policy rules is that of certainty equivalence: given the expected values of all the state variables of the economy, policy should be set in a way that is independent of all higher moments of those variables. Some exceptions to this rule have been pointed out by Smets (1998), who restricts policy to respond to only a limited subset of state variables, and by Orphanides (1998), who restricts policy to respond to estimates of the state variables that are biased. In contrast, this paper studies unrestricted, fully optimal policy rules with optimal estimation of state variables. The rules in this framework exhibit certainty equivalence with respect to estimates of an unobserved, possibly complicated, state of the economy X, but are not certainty-equivalent when 1) a signal-extraction problem is involved in the estimation of X, and 2) the optimal rule is expressed as a reduced form that combines policymakers' estimation and policy-setting stages. In general, I show that it is optimal for policymakers to attenuate their reaction coefficient on a variable about which uncertainty has increased, while responding more aggressively to all other variables, about which uncertainty hasn't changed.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.federalreserve.gov/pubs/feds/2000/200032/200032abs.html
Download Restriction: no

File URL: http://www.federalreserve.gov/pubs/feds/2000/200032/200032pap.pdf
Download Restriction: no

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2000-32.

as
in new window

Length:
Date of creation: 2000
Date of revision:
Handle: RePEc:fip:fedgfe:2000-32
Contact details of provider: Postal: 20th Street and Constitution Avenue, NW, Washington, DC 20551
Web page: http://www.federalreserve.gov/

More information through EDIRC

Order Information: Web: http://www.federalreserve.gov/pubs/feds/fedsorder.html

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
  2. Rudebusch, Glenn D., 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 0014, European Central Bank.
  3. Stephen K. McNees, 1995. "Assessment of the "official" economic forecasts," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 13-23.
  4. Frank Smets, 2002. "Output gap uncertainty: Does it matter for the Taylor rule?," Empirical Economics, Springer, vol. 27(1), pages 113-129.
  5. Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141.
  6. Volker Wieland, . "Monetary Policy and Uncertainty about the Natural Unemployment Rate," Computing in Economics and Finance 1997 11, Society for Computational Economics.
  7. Aoki, Kosuke, 2003. "On the optimal monetary policy response to noisy indicators," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 501-523, April.
  8. Alexei Onatski & James H. Stock, 2000. "Robust Monetary Policy Under Model Uncertainty in a Small Model of the U.S. Economy," NBER Working Papers 7490, National Bureau of Economic Research, Inc.
  9. N. Gregory Mankiw & Matthew D. Shapiro, 1986. "News or Noise? An Analysis of GNP Revisions," NBER Working Papers 1939, National Bureau of Economic Research, Inc.
  10. Glenn D. Rudebusch, 1999. "Is the Fed too timid? Monetary policy in an uncertain world," Working Papers in Applied Economic Theory 99-05, Federal Reserve Bank of San Francisco.
  11. Drew, Aaron & Hunt, Benjamin, 2000. "Efficient simple policy rules and the implications of potential output uncertainty," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 143-160.
  12. Svensson, Lars & Woodford, Michael, 2000. "Indicator Variables for Optimal Policy," Seminar Papers 688, Stockholm University, Institute for International Economic Studies.
  13. Clarida, Richard & GalĂ­, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  14. Arturo Estrella & Frederic S. Mishkin, 2000. "Rethinking the Role of NAIRU in Monetary Policy: Implications of Model Formulation and Uncertainty," NBER Working Papers 6518, National Bureau of Economic Research, Inc.
  15. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.).
  16. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:fip:fedgfe:2000-32. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kris Vajs)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.