67 Pages Posted: 11 Oct 2021
Date Written: October 5, 2021
We study how uncertainty affects decision-making in the context of monetary policy. We exploit the rich informational content of the Federal Open Market Committee (FOMC) meetings to construct text-based measures of uncertainty that policymakers confront as well as policy preferences they express. Our identification relies on the regular structure of the FOMC meetings, which separate discussions of the economic environment from policy deliberations. By distinguishing different sources of uncertainty related to inflation, the real economy, financial markets, and models in the economy round of the meeting, we show their distinct effects on policy preferences. In particular, heightened inflation uncertainty and, to some degree, uncertainty about the real economy lead to an amplification rather than attenuation of the monetary policy response to the macroeconomy. This fact presents a departure from certainty equivalence frequently assumed in monetary models and contrasts with the oft-referenced conservatism principle of policymaking under uncertainty. Instead, the evidence suggests that policymakers display some preference for robustness to avoid costly outcomes. We discuss quantitative implications of our findings for models of optimal monetary policy.
Keywords: uncertainty, monetary policy, Federal Reserve
JEL Classification: E52, E58
Suggested Citation: Suggested Citation