Impact of inflation uncertainty on policy decisions
In this paper, Cieslak et al. explore the impact of uncertainty on the decision-making processes of the Federal Open Market Committee (FOMC). The authors distinguish between two types of uncertainty: Fed-managed uncertainty and economic uncertainty, which is exogenous to policy decisions. They used a textual analysis of FOMC meeting transcripts, and developed indices to measure different types of uncertainty perceived by policymakers. These indices include measures for inflation uncertainty, real economy uncertainty, and financial market uncertainty. Cieslak et al. show that Fed-managed uncertainty, particularly regarding inflation, introduces a significant deviation from standard Taylor-type policy rules, leading to more aggressive policy responses.
Heightened inflation uncertainty leads to more hawkish views of the entire committee and individual members and predicts a tighter policy path up to eight meetings ahead. The economic magnitude of the uncertainty effect on the policy path is comparable to that of the real GDP growth. The FOMC’s expressed uncertainty about inflation relevant to their decision-making is distinct from the public perceptions of uncertainty, objective measures of macroeconomic volatility, and also the uncertainty discussed by the Fed staff.
Policymakers’ Uncertainty
Authors:Anna Cieslak, Stephen Hansen, Michael McMahon, Song Xiao
From: Duke University, University College London, University of Oxford, London School of Economics
Uncertainty over the sources of inflation
In this paper, Mario Carceller del Arco and Jan Willem van den End employ a novel empirical method within a medium-scale Dynamic Stochastic General Equilibrium (DSGE) model to assess how monetary policy can effectively respond to inflation when the contributions of supply and demand shocks are unknown due to real-time observation challenges of the output gap. The authors argue that a robust monetary policy aimed at limiting extreme welfare losses under shock uncertainty should neither be too strong nor too mild. This is based on the probability that supply shocks could be a dominant driver of economic fluctuations. An overly strong response to inflation in scenarios driven by supply shocks could lead to significant adverse effects on output dynamics. When they study the role of shock uncertainty in the US inflationary surge of 2022 they conclude:
[T]here is a high probability that the shock combination that drove the inflation peak is roughly equally driven by supply and demand shocks, in line with previous research, however there is a non-negligible chance (close to 5%) that inflation is almost entirely driven by supply factors. In that case, a strong central bank response to inflation generates large losses, implying that a moderate response is desirable.
Robust Monetary Policy Under Shock Uncertainty
Authors: Mario Carceller del Arco, Jan Willem van den End
From: University of Lausanne, De Nederlandsche Bank
