Working Paper Series no. 175: Does uncertainty make a time-varying natural rate of interest irrelevant for the conduct of monetary policy?

Abstract

We compute optimized monetary policy rules for the ECB when the euro area economy is described by a small empirical macroeconomic model with a time-varying natural interest rate which is positively correlated with fluctuations in trend output growth. We investigate the consequences of both measurement uncertainty with respect to unobservable variables and uncertainty about key model parameters. An optimized Taylor rule with time-varying neutral rate appears to perform well compared to the unconstrained optimal policy, and better than other simple rules found in the literature, even when it is penalized by taking into account both types of uncertainty.

Jean-Stéphane Mésonnier and Jean-Paul Renne
September 2007

Classification JEL : E52, E37.

Keywords : Monetary policy rules, Natural rate of interest, Uncertainty