Policy  Makers' Uncertainty" with Anna Cieslak, Stephen Hansen, and 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 the Fed-driven uncertainty that is induced by the policy choice and the classic notion of uncertainty that emanates from within the economy and which the Fed takes as given. A simple theoretical framework illustrates how the Fed-driven uncertainty introduces a wedge between the standard Taylor-type rule and the optimal decision. Using internal Fed deliberations, we provide the first quantification of the types of uncertainty that the Fed perceives and their effects on the policy stance. The FOMC members’ uncertainty about inflation strongly predicts a more hawkish policy stance that is not explained either by the internal Fed’s forecasts or by the measures of public uncertainty. In contrast, policymakers' uncertainty about growth has no impact on policy decisions beyond these standard controls. Consistent with a model of inflation scares, policymakers’ inflation uncertainty reflects their constant worries about losing the nominal anchor. We argue that the desire to maintain inflation credibility is an important driver of the FOMC's decisions and provide evidence from the FOMC transcripts consistent with this channel.