Working Paper

Monetary policy and uncertainty about the natural unemployment rate

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; Unemployment;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 1998

Number: 1998-22