Hostname: page-component-586b7cd67f-rcrh6 Total loading time: 0 Render date: 2024-11-26T07:16:31.342Z Has data issue: false hasContentIssue false
  • English
  • Français

PARAMETER UNCERTAINTY AND NONLINEAR MONETARY POLICY RULES

Published online by Cambridge University Press:  10 February 2010

Peter Tillmann
Peter Tillmann*
Affiliation:
Justus Liebig University Giessen
*
Address correspondence to: Peter Tillmann, Department of Economics, Justus Liebig University Giessen, Licher Str. 62, D-35394 Giessen, Germany; e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

Empirical evidence suggests that the instrument rule describing the interest rate–setting behavior of the Federal Reserve is nonlinear. This paper shows that optimal monetary policy under parameter uncertainty can motivate this pattern. If the central bank is uncertain about the slope of the Phillips curve and follows a min–max strategy to formulate policy, the interest rate reacts more strongly to inflation when inflation is further away from target. The reason is that the worst case the central bank takes into account is endogenous and depends on the inflation rate and the output gap. As inflation increases, the worst-case perception of the Phillips curve slope becomes larger, thus requiring a stronger interest rate adjustment. Empirical evidence supports this form of nonlinearity for post-1982 U.S. data.

Keywords

Parameter UncertaintyRobust ControlNonlinear Taylor RuleOptimal Monetary PolicyFederal Reserve Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 15 , Issue 2 , April 2011 , pp. 184 - 200
Copyright
Copyright © Cambridge University Press 2010

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Adam, K. (2004) On the relation between robust and Bayesian decision making, Journal of Economic Dynamics and Control 28, 2105–2117.CrossRefGoogle Scholar
Clarida, R., Galí, J., and Gertler, M. (1998) Monetary policy rules in practice: Some international evidence. European Economic Review 42, 1033–1067.CrossRefGoogle Scholar
Clarida, R., Galí, J., and Gertler, M. (2000) Monetary policy rules and macroeconomic stability: Evidence and some theory. Quarterly Journal of Economics 115, 147–180.CrossRefGoogle Scholar
Cukierman, A. and Muscatelli, A. (2008) Nonlinear Taylor rules and asymmetric preferences in central banking: Evidence from the United Kingdom and the United States. B.E. Journal of Macroeconomics (Contributions) 8, Article 7.Google Scholar
Dolado, J., Pedrero, R.M.-D., and Ruge-Murcia, F.J. (2004) Non-linear monetary policy rules: Some new evidence for the U.S. Studies in Nonlinear Dynamics and Econometrics 8 (3), Article 2.Google Scholar
Dolado, J., Maria-Dolores, R., and Naveira, M. (2005) Are monetary policy reactions functions asymmetric? The role of non-linearity in the Phillips curve. European Economic Review 49, 485–503.CrossRefGoogle Scholar
Gerlach-Kristen, P. (2004) Interest rate smoothing: Monetary policy inertia or unobserved variables? B.E. Journals in Macroeconomics (Contributions) 4, Article 4.Google Scholar
Giannoni, M.P. (2002) Does model uncertainty justify caution? Robust optimal monetary policy in a forward-looking model. Macroeconomic Dynamics 6, 111–144.CrossRefGoogle Scholar
Greenspan, A. (2004) Risk and uncertainty in monetary policy. American Economic Review 94, 33–48.CrossRefGoogle Scholar
Hansen, L.P. and Sargent, T.J. (2008) Robustness. Princeton, NJ: Princeton University Press.Google Scholar
Jondeau, E., Le Bihan, H., and Gallès, C. (2004) Assessing generalized method-of-moments estimates of the Federal Reserve reaction function. Journal of Business and Economic Statistics 22, 225–239.CrossRefGoogle Scholar
Judd, J.P. and Rudebusch, G.D. (1998) Taylor's rule and the Fed 1970–1997. Federal Reserve Bank of San Francisco Economic Review 1998, (3).Google Scholar
Kim, D.H., Osborne, D.R., and Sensier, M. (2005) Non-linearity in the Fed's monetary policy rule. Journal of Applied Econometrics 20, 621–639.CrossRefGoogle Scholar
Leigh, D. (2008) Estimating the Federal Reserve's implicit inflation target: A state space approach. Journal of Economic Dynamics and Control 32, 2013–2030.CrossRefGoogle Scholar
Leitemo, K. and Söderström, U. (2008) Robust monetary policy in the New-Keynesian framework. Macroeconomic Dynamics 12, 126–135.CrossRefGoogle Scholar
Meyer, L.H. (2000) Structural Change and Monetary Policy. Remarks before the Joint Conference of the San Francisco Fed and the Stanford Institute of Economic Policy Research, March 3, 2000.Google Scholar
Meyer, L.H., Swanson, E.T., and Wieland, V.W. (2001) NAIRU uncertainty and non-linear policy rules. American Economic Review 91, 226–231.CrossRefGoogle Scholar
Mishkin, F.S. (2008a) Comfort Zones, Shmumfort Zones. Sandridge Lecture at the Virginia Association of Economists, Lexington, Virginia, March 27.Google Scholar
Mishkin, F.S. (2008b) Monetary Policy, Flexibility, Risk Management, and Financial Disruptions. Speech at the Federal Reserve Bank of New York, January 11.Google Scholar
Mizen, P., Kim, T.-H., and Thanaset, A. (2005) Evaluating the Taylor Principle over the Distribution of the Interest Rate: Evidence from the US, UK and Japan. Unpublished, University of Nottingham.Google Scholar
Nobay, A.R. and Peel, D.A. (2000) Optimal monetary policy with a nonlinear Phillips curve. Economics Letters 67, 159–164.CrossRefGoogle Scholar
Nobay, A.R. and Peel, D.A. (2003) Optimal discretionary monetary policy in a model with asymmetric central bank preferences. Economic Journal 113, 657–665.CrossRefGoogle Scholar
Onatski, Alexei and Williams, Noah (2003) Modelling model uncertainty. Journal of the European Economic Association 1, 1087–1122.CrossRefGoogle Scholar
Orphanides, A. and Wieland, V. (2000) Inflation zone targeting. European Economic Review 44, 1351–1387.CrossRefGoogle Scholar
Orphanides, A. and Wilcox, D.W. (2002) The opportunistic approach to disinflation. International Finance 5, 47–71.CrossRefGoogle Scholar
Rudebusch, G.D. (2001) Is the Fed too timid? Monetary policy in an uncertain world. Review of Economics and Statistics 83, 203–217.CrossRefGoogle Scholar
Ruge-Murcia, F.J. (2003) Inflation targeting under asymmetric preferences. Journal of Money, Credit, and Banking 25, 763–785.CrossRefGoogle Scholar
Söderström, U. (2002) Monetary policy with uncertain parameters. Scandinavian Journal of Economics 104, 125–145.CrossRefGoogle Scholar
Surico, P. (2007a) The Fed's monetary policy rule and U.S. inflation: The case of asymmetric preferences. Journal of Economic Dynamics and Control 31, 305–324.CrossRefGoogle Scholar
Surico, P. (2007b) The monetary policy of the European Central Bank. Scandinavian Journal of Economics 109, 115–135.CrossRefGoogle Scholar
Swanson, E.T. (2006) Optimal non-linear policy: Signal extraction with a non-normal prior. Journal of Economic Dynamics and Control 30, 185–203.CrossRefGoogle Scholar
Taylor, J.B. (1993) Discretion vs policy rules in practice. Carnegie–Rochester Conference Series on Public Policy 39, 195–214.CrossRefGoogle Scholar
Walsh, C.E. (2005) Endogenous objectives and the evaluation of targeting rules for monetary policy. Journal of Monetary Economics 52, 889–911.CrossRefGoogle Scholar
Woodford, M. (2003) Interest and Prices. Princeton, NJ: Princeton University Press.Google Scholar