The Effects of Transmission Uncertainty on the Flexibility-Credibility Tradeoff in Monetary Policy

37 Pages Posted: 15 Oct 2007

See all articles by Marc-Alexandre Senegas

Marc-Alexandre Senegas

University of Bordeaux - GRAPE

Jouko Vilmunen

Bank of Finland, Research Unit

Date Written: March 8, 2000

Abstract

In this paper we address the issue of how parameter uncertainty affects the optimal degree of central bank conservatism. The analysis is conducted in the standard macroeconomic model of a monetary policy game embedding an expectational Phillips-curve. Multiplicative "Brainard" uncertainty is added to the model. This means that the central bank's policy instrument has a stochastic impact on inflation. This type of uncertainty is particularly interesting, since it affects the credibility-flexibility tradeoff in monetary policymaking.

We show that if the flexibility problem dominates, an increase in uncertainty reduces optimal conservatism. However, increases in uncertainty can also require increases in the optimal degree of conservatism. This happens when the central bank has a sufficiently large credibility problem. This is particularly clear in the case of the introduction of uncertainty at the margin. Furthermore, the coefficient of variation of inflation appears to contain useful information about the relative size of the credibility problem and, hence, about how incipient uncertainty can affect optimal conservatism in actual economies.

Keywords: credibility, flexibility, monetary policy, conservatism, uncertainty

Suggested Citation

Senegas, Marc-Alexandre and Vilmunen, Jouko, The Effects of Transmission Uncertainty on the Flexibility-Credibility Tradeoff in Monetary Policy (March 8, 2000). Bank of Finland Research Discussion Paper No. 14/1999, Available at SSRN: https://ssrn.com/abstract=1021229 or http://dx.doi.org/10.2139/ssrn.1021229

Marc-Alexandre Senegas

University of Bordeaux - GRAPE ( email )

Avenue Leon Duguit
33608 Pessac Cedex, 33608
France

Jouko Vilmunen (Contact Author)

Bank of Finland, Research Unit ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

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