Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 309: Should central banks be more aggressive?

Ulf Söderström ()
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Ulf Söderström: Research Department, Sveriges Riksbank, Postal: SE-103 37 Stockholm, Sweden

Abstract: Simple models of monetary policy often imply optimal policy behavior that is considerably more aggressive than what is commonly observed. This paper argues that such counterfactual implications are due to model restrictions and a failure to account for multiplicative parameter uncertainty, rather than to policymakers being too cautious in their implementation of policy. Comparing a restricted and an unrestricted version of the same empirical model, the unrestricted version leads to less volatility in optimal policy, and, taking parameter uncertainty into account, to policy paths very close to actual Federal Reserve policy.

Keywords: Optimal monetary policy; parameter uncertainty; interest rate smoothing.

JEL-codes: E52; E58

31 pages, March 8, 1999

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