The Significance of Uncertainty in Monetary Policy

Abstract

Observations seem to indicate that central banks adjust their key rates gradually. Uncertainty regarding economic relationships and measurement errors in the data may point to a need for key rates to be adjusted gradually. Uncertainty relating to possible shocks in exogenous variables on the other hand does not indicate the need for a gradualist approach to setting interest rates. The decisive factor regarding how the uncertainty inherent in monetary policy should be taken into account is whether the setting of interest rates in itself affects the degree of uncertainty and thereby the variance in the outcome of monetary policy. If the setting of interest rates affects both the expected outcome and the uncertainty of the outcome, it will be optimal to take both factors into account. Conclusions in the theoretical literature must be interpreted with caution. The models are highly simplified. Nevertheless, theory makes an important contribution to shedding light on the problems facing central banks in the conduct of monetary policy.