Economic Brief

July 2011, No. 11-07

Monetary Policy with Unknown Natural Rates

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The "unemployment gap" is an important factor in monetary policy decisions. But the size of the gap depends on the level of natural rate of unemployment, which is inherently unobservable. The uncertainty surrounding estimates of the natural rate, and the costs of mismeasuring it, may recommend a policy rule that responds to the rate of change in the actual unemployment rate rather than to the implied unemployment gap.

Additional Resources

Hornstein, Andreas and Thomas A. Lubik, "The Rise in Long-Term Unemployment: Potential Causes and Implications," Federal Reserve Bank of Richmond 2010 Annual Report, pp. 4-23.

Judd, John P., and Glenn D. Rudebusch, "Taylor's Rule and the Fed: 1970-1997," Federal Reserve Bank of San Francisco Economic Review, 1998, no. 3, pp. 3-16.

Krause, Michael U., David Lopez-Salido, and Thomas A. Lubik, "Inflation Dynamics with Search Frictions: A Structural Econometric Analysis," Journal of Monetary Economics, July 2008, vol. 55, no. 5, pp. 892-916.(A working paper version of the article is available online.)

Lubik, Thomas A., "Estimating a Search and Matching Model of the Aggregate Labor Market," Federal Reserve Bank of Richmond Economic Quarterly, Spring 2009, vol. 95, no. 2, pp. 101-120.

Orphanides, Athanasios and John C. Williams, "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, 2002, vol. 2002, no. 2, pp. 63-118.

Orphanides, Athanasios, "Monetary Policy Rules and the Great Inflation," American Economic Review, May 2002, vol. 92, no. 2, pp. 115-120. (A working paper version of the article is available online.)

Staiger, Douglas, James H. Stock, and Mark W. Watson, "How Precise Are Estimates of the Natural Rate of Unemployment?" In Reducing Inflation: Motivation and Strategy, edited by Christina D. Romer and David H. Romer, University of Chicago Press, 1997. (A working paper version of the article is available online.)