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The Risk-Adjusted Monetary Policy Rule

Author

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  • Taisuke Nakata
  • Sebastian Schmidt

Abstract

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.

Suggested Citation

  • Taisuke Nakata & Sebastian Schmidt, 2016. "The Risk-Adjusted Monetary Policy Rule," Finance and Economics Discussion Series 2016-061, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2016-61
    DOI: 10.17016/FEDS.2016.061
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    File URL: http://www.federalreserve.gov/econresdata/feds/2016/files/2016061pap.pdf
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    References listed on IDEAS

    as
    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. Warne, Anders & Coenen, Günter & Christoffel, Kai, 2008. "The new area-wide model of the euro area: a micro-founded open-economy model for forecasting and policy analysis," Working Paper Series 944, European Central Bank.
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Summer’s End — and a reading list to catch up on what you may have missed
      by thebusinesscycleblog in The business cycle blog on 2016-09-03 18:41:38

    More about this item

    Keywords

    Effective Lower Bound ; Inflation Targeting ; Monetary Policy Rule ; Risk ; Risky Steady State;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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