Uncertain Potential Output: Implications for Monetary Policy

By Michael Ehrmann, Frank Smets. Social Science Research Network, 2003

212 citations recorded by the source corpus.

This paper uses a small, calibrated forward-looking model of the euro-area economy to investigate the implications of incomplete information about potential output for the conduct and the design of monetary policy. Three sets of issues are examined. First, the certainty-equivalent optimal policy under both commitment and discretion is characterised. In both cases, incomplete information about potential output leads to very persistent deviations between the actual and the perceived output gap in response to supply and cost-push shocks. The costs of imperfect information are quite large. Second, the implications for simple policy rules such as Taylor or inflation-forecast rule are examined. In first-difference form, both rules continue to perform relatively well with imperfect information as long as the output gap and the inflation forecast are optimally estimated. Third, the implications of potential output uncertainty for the optimal delegation to an independent central bank are examined. Incomplete information implies that it is optimal to appoint a more 'hawkish' central bank. JEL Classification: E52, E31, E17

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/919fdecc1dcc3b5d8b0ddb5e549fc4b557a06556

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In Economics and Econometrics

1. J. Rogers
2. Bo Sun
3. Lucas Husted
4. C. Walsh
5. M. Ferrantino
6. Carlos Thomas
7. R. Hill
8. Ester Faia

In Finance

1. J. Rogers
2. Bo Sun
3. Lucas Husted
4. C. Walsh
5. M. Ferrantino

Citations in the corpus

• Imperfect Information, Real‐Time Data and Monetary Policy in the Euro Area (2012, unknown): “We decided to estimate jointly the standard deviation of the measurement errors and the parameters since Lippi and Neri (2007) found that joint estimation of the two sets of parameters performs better than the two-stage method, adopted in Ehrmann and Smets (2003), in terms of empirical performance.”
• Monetary Theory and Policy, 2nd Edition (2003, background): “Eichenbaum and Fisher (2007) argued that by adding indexation and firm-specific capital and dropping the assumption that firms face a constant elasticity of demand, estimated values of o, the frequency of price changes, are lower than the high values found in the basic Calvo model.”
• Quantifying and Sustaining Welfare Gains from Monetary Commitment (2007, unknown): “Following the pioneering contributions of Kydland and Prescott (1977) and Barro and Gordon (1983), the credibility problem associated with monetary policy has stimulated a huge academic literature that has been influential with policymakers.”
• Data Uncertainty and the Role of Money as an Information Variable for Monetary Policy (2005, unknown): “(1973), Friedman (1975, 1990), Tinsley et al. (1980) and Angeloni et al.”
• Monetary policy uncertainty (2017, background): “Goodfriend (1986) notes that the Federal Reserve formerly held a strong penchant for secrecy.”