Interest Rate Sensitivity Scenarios to Guide Monetary Policy

Allan Dizioli

No 2025/107, IMF Working Papers from International Monetary Fund

Abstract: This paper examines the challenges of formulating monetary policy in the face of heightened uncertainty. We develop a framework to assess the optimal monetary policy path under uncertainty, focusing on four key dimensions: the expectation formation process, inflation persistence, the measurement of the neutral interest rate, and the slope of the Phillips curve. Our framework provides a flexible tool for policymakers to address uncertainty and enhance decision-making in pursuit of economic stability. This framework is helpful to improve the risk management approach to monetary policy by showing how scenarios can quantify different sources of uncertainty faced by the ECB and give market participants an idea of how the ECB would react if those scenarios materialize.

Keywords: DSGE; inflation dynamics; optimal monetary policy; forecasting and simulation; bayesian estimation; interest rate sensitivity scenario; central bank preference; inflation expectation; inflation deviation; policy rule; Inflation; Output gap; Inflation persistence; Rational expectations; Central bank policy rate; Europe (search for similar items in EconPapers)
Pages: 31
Date: 2025-05-30
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