Methods Available to Monetary Policy Makers to Deal with Uncertainty

Three sources – research on monetary policy under uncertainty, the managerial literature, and the real-life strategies of five inflation targeters – have been used to survey methods that are available to monetary policy makers to deal with uncertainty. The methods have been compared within a framework that is based on a decision matrix. The comparative framework has been designed in order to encompass different representations of uncertainty employed by various central banks. The results of comparative analysis suggest that central banks use models, intuition, judgement as well as traditional managerial methods to deal with uncertainty. This finding helps understanding why economic research cannot fully explain differences between monetary policy actions and outcomes of model simulations. The results of the comparative analysis also suggest that central banks have not so far fully utilised the whole spectrum of methods available to them. Economic research, other banks’ strategies as well as decision analysis may be interesting sources of inspiration when designing the decision-making process. It is emphasised that central banks introducing inflation targeting should pay equal attention to both building their forecasting models as well as selecting methods to deal with uncertainty. In the case of emerging economies where uncertainty can be much higher than in advanced economies, neglecting uncertainty may increase probability of policy errors significantly.