Working Paper: CEPR ID: DP18568
Authors: Anna Cieslak; Stephen Hansen; Michael McMahon; Song Xiao
Abstract: Uncertainty is a ubiquitous concern emphasized by policymakers. We study how uncertainty affects decision-making by the Federal Open Market Committee (FOMC). We distinguish between the notion of Fed-managed uncertainty vis-a-vis uncertainty that emanates from within the economy and which the Fed takes as given. A simple theoretical framework illustrates how Fed-managed uncertainty introduces a wedge between the standard Taylor-type policy rule and the optimal decision. Using private Fed deliberations, we quantify the types of uncertainty the FOMC perceives and their effects on its policy stance. The FOMC's expressed inflation uncertainty strongly predicts a more hawkish policy stance that is not explained either by the Fed's macroeconomic forecasts or by public uncertainty proxies. We rationalize these results with a model of inflation tail risks and argue that the effect of uncertainty on the FOMC's decisions reflects policymakers' concern with maintaining credibility for the inflation anchor.
Keywords: Monetary Policy; Uncertainty; Inflation
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perceived inflation uncertainty (inflation PMU) (E31) | more hawkish policy stance (E63) |
| perceived inflation uncertainty (inflation PMU) (E31) | federal funds rate (E52) |
| perceived real economy uncertainty (real economy PMU) (E39) | easier (dovish) policy stance (E63) |