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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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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. Marvin Goodfriend, 1986. "Interest rate smoothing and price level trend-stationarity," Working Paper 86-04, Federal Reserve Bank of Richmond.
  2. Geoffrey Shuetrim & Christopher Thompson, 2003. "The Implications of Uncertainty for Monetary Policy," The Economic Record, The Economic Society of Australia, vol. 79(246), pages 370-379, 09.
  3. Ben Martin & Chris Salmon, 1999. "Should uncertain monetary policy-makers do less?," Bank of England working papers 99, Bank of England.
  4. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  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. Alexei Onatski & James H. Stock, 1999. "Robust monetary policy under model uncertainty in a small model of the U.S. economy," Proceedings, Federal Reserve Bank of San Francisco.
  7. Thomas Mayer, 1999. "Monetary Policy and the Great Inflation in the United States," Books, Edward Elgar Publishing, number 1601.
  8. Mankiw, N. Gregory, 1987. "The optimal collection of seigniorage : Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 327-341, September.
  9. David L. Reifschneider & Robert J. 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.
  10. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  11. 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.
  12. 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.
  13. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
  14. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  15. Barro, Robert J., 1989. "Interest-rate targeting," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 3-30, January.
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