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

Flamini, A. and Milas, C. (2010) Real-time Optimal Monetary Policy with Undistinguishable Model Parameters and Shock Processes Uncertainty. Working Paper. Department of Economics, University of Sheffield ISSN 1749-8368

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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.

Item Type: Monograph (Working Paper)
Copyright, Publisher and Additional Information: The Sheffield Economics Research Paper (SERP) series offers a forum for the research output of the academic staff and research students of the Department of Economics, University of Sheffield. Papers are reviewed for quality and presentation by a departmental editor. However, the contents and opinions expressed remain the responsibility of the authors. All papers may be downloaded free on the understanding that the contents are preliminary and therefore permission from the author(s) should be sought before they are referenced.
Keywords: Multiplicative uncertainty; Markov jump linear quadratic systems; optimal monetary policy
Academic Units: The University of Sheffield > Faculty of Social Sciences (Sheffield) > Department of Economics (Sheffield) > Sheffield Economics Research Papers Series
Depositing User: Repository Officer
Date Deposited: 23 Jun 2010 17:48
Last Modified: 08 Feb 2013 17:00
Published Version: http://www.shef.ac.uk/economics/research/serps/yea...
Status: Published
Publisher: Department of Economics, University of Sheffield
Identification Number: Sheffield Economic Research Paper Series 2010015
URI: http://eprints.whiterose.ac.uk/id/eprint/10960

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