Central banks operate with incomplete understanding of economic variables, necessitating cautious monetary policy approaches.
Economic Understanding Remains Incomplete
Our understanding of economic mechanisms continues to be incomplete. Economic variables that play a role in monetary policy, such as the natural interest rate, are not observable and must be estimated based on data. This means we never have certainty about their actual values.
Similarly, model parameters – such as the slope of the Phillips curve, which determines the relationship between inflation and unemployment – remain subject to revision.
Monetary Policy Under Uncertainty
How should monetary policy look under conditions of uncertainty? Quoting ECB President Mario Draghi from 2019: “In a dark room, you move with small steps.” This approach is known as the Brainard rule.
