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The Effect of Uncertainty on Monetary Policy: How Good are the Brakes?

  • Guy Debelle

    (Reserve Bank of Australia)

  • Adam Cagliarini

    (Reserve Bank of Australia)

In practice, monetary policy changes tend to produce a smooth path for interest rates while the path of policy interest rates generated by models is often considerably more variable. This paper investigates whether the inclusion of uncertainty can help reconcile the theory to the practice. It shows that parameter uncertainty does not induce much smoothness when its effects are directly incorporated into a model. Uncertainty about the interest sensitivity of output can increase the smoothness of optimal policy in a model, but the path of policy interest rates generated is still considerably more variable than that observed in practice.

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File URL: http://www.rba.gov.au/publications/rdp/2000/pdf/rdp2000-07.pdf
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Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2000-07.

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Date of creation: Oct 2000
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Handle: RePEc:rba:rbardp:rdp2000-07
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  1. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  2. N. Gregory Mankiw, 1987. "The Optimal Collection of Seigniorage: Theory and Evidence," NBER Working Papers 2270, National Bureau of Economic Research, Inc.
  3. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
  4. Marvin Goodfriend, 1986. "Interest rate smoothing and price level trend-stationarity," Working Paper 86-04, Federal Reserve Bank of Richmond.
  5. Eijffinger, S.C.W. & Schaling, E. & Verhagen, W.H., 1999. "A Theory of Interest Rate Stepping : Inflation Targeting in a Dynamic Menu Cost Model," Discussion Paper 1999-71, Tilburg University, Center for Economic Research.
  6. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  7. Geoffrey Shuetrim & Christopher Thompson, 1999. "The Implications of Uncertainty for Monetary Policy," RBA Research Discussion Papers rdp1999-10, Reserve Bank of Australia.
  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. Barro, Robert J., 1989. "Interest-rate targeting," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 3-30, January.
  10. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  11. David Reifschneider & Robert Tetlow & John Williams, 1999. "Aggregate disturbances, monetary policy, and the macroeconomy: the FRB/US perspective," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-19.
  12. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
  13. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
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