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The Risk-Adjusted Monetary Policy Rule

Listed author(s):
  • Taisuke Nakata
  • Sebastian Schmidt

Macroeconomists are increasingly using nonlinear models to account for the effects of risk in the analysis of business cycles. In the monetary business cycle models widely used at central banks, an explicit recognition of risk generates a wedge between the inflation-target parameter in the monetary policy rule and the risky steady state (RSS) of inflation---the rate to which inflation will eventually converge---which can be undesirable in some practical applications. We propose a simple modification to the standard monetary policy rule to eliminate the wedge. In the proposed risk-adjusted policy rule, the intercept of the rule is modified so that the RSS of inflation equals the inflation-target parameter in the policy rule.

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File URL: http://www.federalreserve.gov/econresdata/feds/2016/files/2016061pap.pdf
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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 2016-061.

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Length: 21 pages
Date of creation: Jul 2016
Handle: RePEc:fip:fedgfe:2016-61
DOI: 10.17016/FEDS.2016.061
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  1. Günter Coenen & Anders Warne, 2014. "Risks to Price Stability, the Zero Lower Bound, and Forward Guidance: A Real-Time Assessment," International Journal of Central Banking, International Journal of Central Banking, vol. 10(2), pages 7-54, June.
  2. Christoffel, Kai & Coenen, Günter & Warne, Anders, 2008. "The New Area-Wide Model of the euro area: a micro-founded open-economy model for forecasting and policy analysis," Working Paper Series 0944, European Central Bank.
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