IMPLICATIONS OF PARAMETER UNCERTAINTY FOR THE CBN’S MONETARY POLICY

N’Yilimon NANTOB

Abstract

This paper examines the empirical importance of multiplicative parameter uncertainty on the conduct of the Central Bank of Nigeria’s monetary policy over the period 1980Q1–2015Q1. Theoretically, the certainty equivalence principle indicates that the optimal policy is not affected by the degree of uncertainty called “additive”. However, the “Brainard conservatism principle” states that under uncertainty about the transmission mechanism, monetary policy should be less aggressive than in certainty universe. We show in this study that the Brainard principle can be challenged not only by the choice of the model used but also by the preferences of the central bank. Using the framework of a parameterized model with parsimony of IS curve-Phillips curve-type and a simple rule, and the linear quadratic stochastic control approach by introduction the variance of the estimated parameters in the optimal control theory the results yield that the central banker are always very cautious when they have an inflation and output stabilization objective. However, when they are concerned to smooth interest rate, their behavior becomes more aggressive, with a degree of aggressiveness that depends in part on the objective of interest rate smoothing.

 

Keywords: Optimal monetary policy, Parameter uncertainty, Brainard conservatism principle, Interest rate smoothing, Nigeria.

JEL classification: E43, E52, E58.

 

IMPLICATIONS OF PARAMETER UNCERTAINTY FOR THE CBN’S MONETARY POLICY