Uncertainty and Simple Monetary Policy Rules - An illustration for the United Kingdom

Abstract

5 1 Introduction 7 2 Monetary policy and uncertainty 7 3 Method 13 4 Results 21 5 Conclusions 29 Data Appendix 32 References 34 5 Abstract We investigate the effects of additive and multiplicative uncertainty upon the stabilisation properties of a simple base money rule for monetary policy. Using a five-equation empirical model of the United Kingdom, we show that changes in the extent of additive uncertainty have no effect upon the `optimal' degree of policy responsiveness to shocks to the economy. However, we find that policy-makers should respond by less to shocks in the face of multiplicative uncertainty. And as multiplicative uncertainty rises, so the optimal degree of policy reaction falls. This accords with Brainard's (1967) theoretical analysis and could be interpreted as justifying a gradualist monetary policy. 7 Introduction In 1990, Benjamin Friedman wrote that `the making of monetary policy... involves both skill and chance'. Few (and perhaps even fewer central banke...

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