The Risk-Adjusted Monetary Policy Rule

22 Pages Posted: 10 Aug 2016

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Sebastian Schmidt

European Central Bank (ECB)

Multiple version iconThere are 2 versions of this paper

Date Written: 2016-07

Abstract

Macroeconomists are increasingly using nonlinear models to account for the effects of risk in the analysis of business cycles. In the monetary business cycle models widely used at central banks, an explicit recognition of risk generates a wedge between the inflation-target parameter in the monetary policy rule and the risky steady state (RSS) of inflation---the rate to which inflation will eventually converge---which can be undesirable in some practical applications. We propose a simple modification to the standard monetary policy rule to eliminate the wedge. In the proposed risk-adjusted policy rule, the intercept of the rule is modified so that the RSS of inflation equals the inflation-target parameter in the policy rule.

Keywords: Effective Lower Bound, Inflation Targeting, Monetary Policy Rule, Risk, Risky Steady State

JEL Classification: E32, E52

Suggested Citation

Nakata, Taisuke and Schmidt, Sebastian, The Risk-Adjusted Monetary Policy Rule (2016-07). FEDS Working Paper No. 2016-061. Available at SSRN: https://ssrn.com/abstract=2820957 or http://dx.doi.org/10.17016/FEDS.2016.061

Taisuke Nakata (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Sebastian Schmidt

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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