Welfare costs of monetary policy uncertainty in the economy with shifting trend inflation

Abstract

AbstractWe study welfare costs of the uncertainty about monetary policy in the economy featuring shifting trend inflation. We follow Ruge‐Murcia (J Econ Dyn Control 36: 914–‐938, 2012) to employ the SMM approach to fit the model to the US data (1979Q1‐2015Q1). We find that the monetary policy uncertainty affects economic welfare through different dimensions. On the one hand, the policy uncertainty itself distorts the economic welfare negligibly, not only by increasing volatilities of consumption and leisure, but also by decreasing their average levels. A higher level of trend inflation then signifies these changes to produce greater welfare costs. Furthermore, the adverse impacts of policy uncertainty on the economy, documented by the impulse response functions of macroeconomic variables to policy uncertainty shock, become larger when central banks raise their inflation targets. On the other hand, the costs of exogenous variations in trend inflation are larger if there is policy uncertainty.