Introduction

This lecture focuses on the special difficulties of monetary policy making under realistic levels of uncertainty. The kind of question I have at the back of my mind is not related to the optimal setting of monetary policy within a certain model. It is connected to actual decision making and can thus be phrased as follows: how should policy be set given past dynamics and current values of available observable variables? In other words, I realistically acknowledge that, to provide a concrete example, it is not simply the case that the output gap is unobservable and difficult to measure and estimate, but also that both its definition and its role in influencing inflation dynamics are ambiguous.

One problem with trying to answer directly this sort of question is that a formal treatment becomes impossible. I should therefore clarify that I do believe that mathematical models have been beneficial for economics, as they have allowed the discipline to reach results which would have been impossible to achieve without formal methods. Nevertheless, the usefulness of models should never lead us to believe that they are true representations of the world. When formal elegance becomes an end – rather than a means to an end – for theoretical research, theory risks being of little help as a guide for practical decision making.