DP6826 Monetary Policy Under Uncertainty in an Estimated Model with Labour Market Frictions

Author(s): Luca Sala , Ulf Söderström , Antonella Trigari

Publication Date: May 2008

Keyword(s): Labour market search , Monetary policy , Natural rate uncertainty , Parameter uncertainty , Unemployment

JEL(s): E24 , E32 , E52 , J64

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6826.asp.asp

We study the design of monetary policy in an estimated model with sticky prices, search and matching frictions, and staggered nominal wage bargaining. We find that the estimated natural rate of unemployment is consistent with the NBER description of the U.S. business cycle, and that the inflation/unemployment trade-off facing monetary policymakers is quantitatively important. We also show that parameter uncertainty has a limited effect on the performance or design of monetary policy, while natural rate uncertainty has more sizeable effects. Nevertheless, policy rules that respond to the output or unemployment gaps are more efficient than rules responding to output or unemployment growth rates, also in the presence of uncertainty about the natural rates.