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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Monetary Policy and Uncertainty about the Natural Unemployment Rate
Volker Wieland

Abstract: This paper studies the optimal monetary policy in the presence of uncertainty about the natural rate and the short-run inflation-unemployment tradeoff. Two conflicting motives drive policy. In the static version of the model, uncertainty provides a motive for the policymaker to move cautiously. In the dynamic version, uncertainty motivates an element of experimentation. I find that the optimal policy that balances these motives typically still exhibits gradualism, i.e., is less aggressive than a policy that disregards parameter uncertainty. Exceptions occur when uncertainty is very high and inflation close to target.

Keywords: Monetary policy, gradualism, parameter uncertainty, learning experimentation, NAIRU

Full paper (363 KB PDF) | Full paper (437 KB Postscript)

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Last update: June 30, 1998