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Monetary Policy-making in the Presence of Knightian Uncertainty

Author

Listed:
  • Adam Cagliarini

    (Reserve Bank of Australia)

  • Alexandra Heath

    (Reserve Bank of Australia)

Abstract

This paper explores the extent to which Knightian uncertainty can explain features of interest rate paths observed in practice that are not generally replicated by models of optimal monetary policy. Interest rates tend to move in a sequence of steps in a given direction, or remain constant for some time, rather than experiencing the frequent reversals that commonly arise from optimal policy simulations. We categorise the types of uncertainty that have been explored to date in terms of the decision-making behaviour they imply. From this, we suggest a more intuitively appealing formulation of Knightian uncertainty than the one that has previously been used in the analysis of monetary policy. Within a very simple optimal control problem, we show that our preferred formalisation is consistent with interest rate paths with periods of no change. This suggests that the presence of Knightian uncertainty may explain some features of monetary policy-makers’ behaviour.

Suggested Citation

  • Adam Cagliarini & Alexandra Heath, 2000. "Monetary Policy-making in the Presence of Knightian Uncertainty," RBA Research Discussion Papers rdp2000-10, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp2000-10
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    File URL: https://www.rba.gov.au/publications/rdp/2000/pdf/rdp2000-10.pdf
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    References listed on IDEAS

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    Cited by:

    1. Angus Moore, 2017. "Measuring Economic Uncertainty and Its Effects," The Economic Record, The Economic Society of Australia, vol. 93(303), pages 550-575, December.
    2. Katerina Smidkova, 2003. "Methods Available to Monetary Policy Makers to Deal with Uncertainty," Macroeconomics 0310002, University Library of Munich, Germany.
    3. Nicholas Apergis, 2022. "Evaluating tail risks for the U.S. economic policy uncertainty," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(4), pages 3971-3989, October.
    4. Ghatak, Subrata & Spanjers, Willem, 2007. "Monetary policy rules in transition economies: the impact of ambiguity," Economics Discussion Papers 2007-2, School of Economics, Kingston University London.
    5. Spanjers, Willy, 2008. "Central banks and ambiguity," International Review of Economics & Finance, Elsevier, vol. 17(1), pages 85-102.
    6. Mariusz Górajski, 2018. "Robust Monetary Policy in a Model of the Polish Economy: Is the Uncertainty Responsible for the Interest Rate Smoothing Effect?," Computational Economics, Springer;Society for Computational Economics, vol. 52(2), pages 313-340, August.
    7. André P. Calmon & Thomas Vallée & João B. R. Do Val, 2009. "Monetary policy as a source of uncertainty," Working Papers hal-00422454, HAL.
    8. Katerina Smidkova, 2003. "Targeting Inflation under Uncertainty: Policy Makers' Perspective," Research and Policy Notes 2003/02, Czech National Bank.
    9. Ngozi E. Egbuna (PhD) & Maimuna John-Sowe & Dauda Mohammed (PhD) & Hissan Abubakari & Eric L. Sambolah & Kormay Adams, 2020. "Uncertainty And Economic Performance In The West African Monetary Zone (Wamz): A Fixed Effect Panel Threshold Approach," Working Papers 19, West African Monetary Institute.

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    More about this item

    Keywords

    Knightian uncertainty; monetary policy;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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