Real-time Optimal Monetary Policy with Undistinguishable Model Parameters and Shock Processes Uncertainty

Alessandro Flamini () and Costas Milas

No 2010015, Working Papers from The University of Sheffield, Department of Economics

Abstract: This paper studies optimal real-time monetary policy when the central bank takes the exogenous volatility of the output gap and inflation as proxy of the undistinguishable uncertainty on the exogenous disturbances and the parameters of its model. The paper shows that when the exogenous volatility surrounding a specific state variable increases, the optimal policy response to that variable should increase too, while the optimal response to the remaining state variables should attenuate or be unaffected. In this way the central bank moves preemptively to reduce the risk of large deviations of the economy from the steady state that would deteriorate the distribution forecasts of the output gap and inflation. When an empirical test is carried out on the US economy the model predictions tend to be consistent with the data.

Keywords: Multiplicative uncertainty; Markov jump linear quadratic systems; optimal monetary policy (search for similar items in EconPapers)
JEL-codes: C51 C52 E52 E58 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2010-06, Revised 2010-06
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-ore
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Downloads: (external link)
http://www.shef.ac.uk/economics/research/serps/articles/2010_015.html First version, 2010 (application/pdf)

Related works:
Journal Article: Real-Time Optimal Monetary Policy with Undistinguishable Model Parameters and Shock Processes Uncertainty (2011)
Working Paper: Real-time Optimal Monetary Policy with Undistinguishable Model Parameters and Shock Processes Uncertainty (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:shf:wpaper:2010015

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