Does Monetary Policy Respond to Uncertainty? Evidence from Australia

• Author: Jeffrey Sheen,Natalia Ponomareva,Ben Zhe Wang
• DOI: http://doi.org/10.1111/1467-8462.12338
• Published date: 01 September 2019
• Date: 01 September 2019

The Australian Economic Review, vol. 52, no. 3, pp. 336–343 DOI: 10.1111/1467-8462.12338

Does Monetary Policy Respond to Uncertainty? Evidence from

Australia

1

Natalia Ponomareva, Jeffrey Sheen and Ben Zhe Wang*

Abstract

We construct a novel measure of uncertainty

using expert monetary policy recommendation

data for Australia. Our results suggest that

the Reserve Bank of Australia (RBA) tends to

lower the cash rate when expert uncertainty is

high. This result is robust to using other

uncertainty measures.

1. Introduction

When considering a monetary policy change,

decision makers at the Reserve Bank of

Australia (RBA) undoubtedly take into account

a significant amount of information about the

economy. Reported data and macroeconomic

models, along with the RBA Board’s prefer-

ences, are vital elements in deciding whether a

policy change is required. However, policy

decision makers surely have some reservations

about the quality of data they use, the relevance

of the competing models that they may consider

and even their own preferences when arriving at

these decisions.

1

These reservations reflect their

perceived uncertainty, which must moderate the

confidence held about any monetary policy

decision. For instance, the Minutes of the

Monetary Policy Meeting of the Reserve Bank

Board from 5 March 2019 states:

Taking account of the available information on current

economic and financial conditions and how they were

expected to evolve, members assessed that the current

stance of monetary policy was supporting jobs growth

and a gradual lift in inflation. However, members

noted that significant uncertainties around the fore-

casts remained, with scenarios where an increase in

the cash rate would be appropriate at some point and

other scenarios where a decrease in the cash rate

would be appropriate. The probabilities around these

scenarios were more evenly balanced than they had

been over the preceding year.

This brings up a question: How exactly

does uncertainty affect monetary policy

decisions?

How central banks should best conduct

monetary policy in the light of uncertainty has

* Ponomareva, Sheen and Wang: Macquarie University,

Sydney 2109 Australia. Corresponding author: Wang,

email <ben.wang@mq.edu.au>.

We thank the special issue editor, Efrem Castelnuovo for

helpful comments. This research is supported by the

German Academic Exchange Service DAAD (under the

Australia–Germany Joint Research Cooperation Scheme)

and Macquarie University (Macquarie University

Research Seeding Grant).

© 2019 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research,

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd