Monetary Policy Evaluation with Noisy Information

36 Pages Posted: 6 May 1999

See all articles by Athanasios Orphanides

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Asia School of Business

Date Written: October 1998

Abstract

This paper investigates the implications of noisy information regarding the measurement of economic activity for the evaluation of monetary policy. A common implicit assumption in such evaluations is that policymakers observe the current state of the economy promptly and accurately and can therefore adjust policy based on this information. However, in reality, decisions are made in real time when there is considerable uncertainty about the true state of affairs in the economy. Policy must be made with partial information. Using a simple model of the U.S. economy, I show that failing to account for the actual level of information noise in the historical data provides a seriously distorted picture of feasible macroeconomic outcomes and produces inefficient policy rules. Naive adoption of policies identified as efficient when such information noise is ignored results in macroeconomic performance worse than actual experience. When the noise content of the data is properly taken into account, policy reactions are cautious and less sensitive to the apparent imbalances in the unfiltered data. The resulting policy prescriptions reflect the recognition that excessively activist policy can increase rather than decrease economic instability.

JEL Classification: E52, E58

Suggested Citation

Orphanides, Athanasios, Monetary Policy Evaluation with Noisy Information (October 1998). Available at SSRN: https://ssrn.com/abstract=148729 or http://dx.doi.org/10.2139/ssrn.148729

Athanasios Orphanides (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

Asia School of Business ( email )

Jalan Kuching, Kuala Lumpur, Wilayah Persekutuan K
Kuala Lumpur, MA
Malaysia

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