The Federal Reserve Board eagle logo links to home page
Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Monetary Policy, Parameter Uncertainty and Optimal Learning
Volker Wieland

Abstract: Since central banks have limited information concerning the transmission channel of monetary policy, they are faced with the difficult task of simultaneously controlling the policy target and estimating the impact of policy actions. A tradeoff between estimation and control arises because policy actions influence estimation and provide information which may improve future performance. I analyze this tradeoff in a simple model with parameter uncertainty and conduct dynamics simulations of the policymaker's decision problem in the presence of the type of uncertainties that arose in the wake of German reunification. A policy that separates learning from control may induce a persistent upward bias in money growth and inflation, just as observed after unification. In contrast, the optimal learning strategy which exploits the tradeoff between control and estimation significantly improves stabilization performance and reduces the likelihood of inflationary bias.

Keywords: optimal control with unknown parameters, Bayesian learning, monetary policy, inflation targeting

Full paper (3356 KB PDF)

Home | FEDS | List of 1999 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: October 20, 1999