Efficient simple policy rules and the implications of uncertainty about potential output

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. However, potential output is unobservable and is estimated with uncertainty. We examine the effects that this uncertainty has on the stabilisation properties of three classes of simple efficient policy rules. Although the stabilisation 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. 1 Economics Department, Reserve Bank of New Zealand. The views expressed in this paper are those of the authors and do not necessarily represent the views of the Reserve Bank of New Zealand. The authors would like to thank an anonymous referee, Ralph Bryant and participants at a workshop on ‘Monetary Policy Under Uncertainty’, held at the Reserve Bank in June 1998, for comments on an earlier version of the paper. Any remaining errors and omissions are the responsibility of the authors.