Efficient simple policy rules and the implications of potential output uncertainty

Abstract

Simple rules for guiding monetary policy actions have been shown to achieve policy objectives effectively. In many of these simple rules, policy prescriptions depend on the economy’s level of potential output. Potential output is unobservable, however, and is estimated with uncertainty. We examine the effects that this uncertainty has on the stabilization properties of three classes of simple efficient policy rules. Although the stabilization properties deteriorate under uncertainty, the deterioration is less pronounced for rules that use forecasts of inflation rather than just contemporaneous inflation. Under the uncertainty considered, the magnitudes of the efficient response coefficients tend to increase.