Policymakers' Uncertainty

71 Pages Posted: 11 Oct 2021 Last revised: 9 May 2022

See all articles by Anna Cieslak

Anna Cieslak

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Stephen Hansen

Imperial College Business School

Michael McMahon

University of Oxford

Song Xiao

London School of Economics & Political Science (LSE)

Date Written: October 5, 2021

Abstract

Deviations from a policy rule underpin empirical identification of monetary policy shocks. We cast light on how deviations arise by analyzing internal policy deliberations of the Federal Open Market Committee (FOMC). We show that policymakers’ beliefs about higher-order moments of economic distributions – specifically perceptions of uncertainty and skewness – significantly impact policy stance beyond economic forecasts typically used in rule estimates. To capture those otherwise unobservable decision-making features, we construct text-based proxies for policymakers’ uncertainty, sentiment, and policy stance from the FOMC meeting transcripts over the 1987--2015 period. Heightened uncertainty generally amplifies the policymakers’ response to the macroeconomy. However, while an increased uncertainty about the real economy drives an easier stance, inflation uncertainty leads to more hawkishness. We show that policymakers’ inflation uncertainty is associated with their skewed beliefs about rising inflation, which do not materialize in our sample. The results depart from the certainty equivalence arising in classic monetary models and contrast with the frequently-referenced conservatism in policymaking under uncertainty. Instead, the evidence suggests that policymakers act aggressively to avoid low-probability costly outcomes which are endogenous to their policy actions.

Keywords: uncertainty, monetary policy, Federal Reserve

JEL Classification: E52, E58

Suggested Citation

Cieslak, Anna and Hansen, Stephen and McMahon, Michael and Xiao, Song, Policymakers' Uncertainty (October 5, 2021). Available at SSRN: https://ssrn.com/abstract=3936999 or http://dx.doi.org/10.2139/ssrn.3936999

Anna Cieslak (Contact Author)

Duke University - Fuqua School of Business ( email )

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HOME PAGE: https://sites.google.com/site/ancieslak/

National Bureau of Economic Research (NBER) ( email )

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Stephen Hansen

Imperial College Business School ( email )

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Michael McMahon

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

Song Xiao

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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