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Monetary policy with uncertain parameters

In a simple dynamic macroeconomic model, it is shown that uncertainty about structural parameters does not necessarily lead to more cautious monetary policy, refining the accepted wisdom concerning the effects of parameter uncertainty on optimal policy. In particular, when there is uncertainty about the persistence of inflation, it is optimal for the central bank to respond more aggressively to shocks than if the parameter were known with certainty, since the central bank wants to avoid bad outcomes in the future. Uncertainty about other parameters, in contrast, acts to dampen the policy response.

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Paper provided by Stockholm School of Economics in its series SSE/EFI Working Paper Series in Economics and Finance with number 308.

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Length: 21 pages
Date of creation: 08 Mar 1999
Date of revision:
Publication status: Published in Scandinavian Journal of Economics, 2002, pages 125-145.
Handle: RePEc:hhs:hastef:0308
Contact details of provider: Postal: The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden
Phone: +46-(0)8-736 90 00
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  1. Christina D. Romer, 1996. "Inflation and the Growth Rate of Output," NBER Working Papers 5575, National Bureau of Economic Research, Inc.
  2. Arturo Extrella & Jeffrey C. Fuhrer, 1998. "Dynamic inconsistencies: counterfactual implications of a class of rational expectations models," Working Papers 98-5, Federal Reserve Bank of Boston.
  3. Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies.
  4. Geoffrey Shuetrim & Christopher Thompson, 1999. "The Implications of Uncertainty for Monetary Policy," RBA Research Discussion Papers rdp1999-10, Reserve Bank of Australia.
  5. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Working Papers in Applied Economic Theory 98-03, Federal Reserve Bank of San Francisco.
  6. Basar, Tamer & Salmon, Mark, 1990. "Credibility and the value of information transmission in a model of monetary policy and inflation," Journal of Economic Dynamics and Control, Elsevier, vol. 14(1), pages 97-116, February.
  7. Tore Ellingsen & Ulf Soderstrom, 2001. "Monetary Policy and Market Interest Rates," American Economic Review, American Economic Association, vol. 91(5), pages 1594-1607, December.
  8. William Poole, 1998. "A policymaker confronts uncertainty," Speech 88, Federal Reserve Bank of St. Louis.
  9. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc.
  10. Balvers, Ronald J & Cosimano, Thomas F, 1994. "Inflation Variability and Gradualist Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 61(4), pages 721-38, October.
  11. Orphanides, Athanasios & Wieland, Volker, 2000. "Inflation zone targeting," European Economic Review, Elsevier, vol. 44(7), pages 1351-1387, June.
  12. Wieland, Volker, 2003. "Monetary Policy and Uncertainty about the Natural Unemployment Rate," CFS Working Paper Series 2003/05, Center for Financial Studies (CFS).
  13. 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.
  14. Glenn D. Rudebusch, 2001. "Is The Fed Too Timid? Monetary Policy In An Uncertain World," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 203-217, May.
  15. Stephen G. Cecchetti, 1998. "Policy rules and targets: framing the central banker's problem," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 1-14.
  16. Bertocchi, Graziella & Spagat, Michael, 1993. "Learning, experimentation, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 169-183, August.
  17. Onatski, Alexei & Stock, James H., 2002. "Robust Monetary Policy Under Model Uncertainty In A Small Model Of The U.S. Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 85-110, February.
  18. Jeffrey C. Fuhrer, 1994. "Optimal monetary policy and the sacrifice ratio," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 43-84.
  19. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
  20. Charles Goodhart, 1998. "Central Bankers and Uncertainty," FMG Special Papers sp106, Financial Markets Group.
  21. Srour, Gabriel, 1999. "Inflation Targeting under Uncertainty," Technical Reports 85, Bank of Canada.
  22. 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.).
  23. 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.
  24. Stanley Fischer, 1996. "Why are central banks pursuing long-run price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 7-34.
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