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Aiming for the Bull's Eye: Uncertainty and Inertia in Monetary Policy


  • Maria Demertzis

    (De Nederlandsche Bank)

  • Nicola Viegi

    (University of KwaZulu-Natal)


We study the implications of uncertainty for inflation targeting. We apply multiplicative uncertainty to a standard forward looking model and demonstrate Brainard's attenuation effect. But the result as monetary authorities become naturally more cautious at the same time monetary objectives are seldom achieved. We therefore attempt to find a monetary rule that reaches the objectives set more often and improves the welfare of the Central Bank. To do that, we assume that private sector expectations are subject to differentiated information, thereby introducing inertia in the system. Such a rule is the result of a new algorithm that we put forward, in which the inflation target is state contingent. The Central Bank sets therefore (as an auxiliary step), a variable inflation target that depends on both the degree of uncertainty as well as the shocks that occur each time. We show that such an optimisation procedure helps the CB\ attain its objectives more often, thereby reducing the losses incurred. Moreover, and as a corollary to such an approach, the rule derived is ex ante neutral to the degree of uncertainty

Suggested Citation

  • Maria Demertzis & Nicola Viegi, 2006. "Aiming for the Bull's Eye: Uncertainty and Inertia in Monetary Policy," Computing in Economics and Finance 2006 150, Society for Computational Economics.
  • Handle: RePEc:sce:scecfa:150

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    References listed on IDEAS

    1. Maria Demertzis & Nicola Viegi, 2008. "Inflation Targets as Focal Points," International Journal of Central Banking, International Journal of Central Banking, vol. 4(1), pages 55-87, March.
    2. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    4. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
    5. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    6. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August.
    7. Schellekens, Philip, 2002. "Caution and Conservatism in the Making of Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 160-177, February.
    8. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
    9. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June.
    10. Stephen Morris & Hyun Song Shin, 2006. "Inertia of Forward-Looking Expectations," American Economic Review, American Economic Association, vol. 96(2), pages 152-157, May.
    11. Faust, Jon & Svensson, Lars E O, 2001. "Transparency and Credibility: Monetary Policy with Unobservable Goals," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 369-397, May.
    12. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
    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. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 111-144, February.
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    Cited by:

    1. Maria Demertzis, 2006. "The Role of Expectations in Monetary Policy," International Finance, Wiley Blackwell, vol. 9(3), pages 393-412, December.

    More about this item


    Inflation Targeting; Brainard Uncertainty; Two-Step Target; Differential Information;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy


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