Monetary policy and uncertainty about the natural unemployment rate

  • Inflation-targeting central banks have only imperfect knowledge about the effect of policy decisions on inflation. An important source of uncertainty is the relationship between inflation and unemployment. This paper studies the optimal monetary policy in the presence of uncertainty about the natural unemployment rate, the short-run inflation-unemployment tradeoff and the degree of inflation persistence in a simple macroeconomic model, which incorporates rational learning by the central bank as well as private sector agents. Two conflicting motives drive the optimal policy. In the static version of the model, uncertainty provides a motive for the policymaker to move more cautiously than she would if she knew the true parameters. In the dynamic version, uncertainty also motivates an element of experimentation in policy. I find that the optimal policy that balances the cautionary and activist motives typically exhibits gradualism, that is, it still remains less aggressive than a policy that disregards parameter uncertainty. Exceptions occur when uncertainty is very high and in inflation close to target.

Download full text files

Export metadata

Additional Services

Share in Twitter Search Google Scholar
Author:Volker WielandORCiDGND
Parent Title (German):Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 2003,05
Series (Serial Number):CFS working paper series (2003, 05)
Document Type:Working Paper
Year of Completion:2003
Year of first Publication:2003
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2005/06/13
Tag:inflation targeting; monetary policy; natural unemployment rate; optimal learning; parameter uncertainty
GND Keyword:Notenbank; Geldpolitik; Inflation; Arbeitslosigkeit
Issue:This version: December 2002
Institutes:Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
JEL-Classification:C Mathematical and Quantitative Methods / C6 Mathematical Methods and Programming / C61 Optimization Techniques; Programming Models; Dynamic Analysis
Licence (German):License LogoDeutsches Urheberrecht