to the marginal response under certainty equivalence. monetary policy ’ s adjustment to uncertainty about key parameters is the recent monetary policy response consistent with the lessons i have drawn from the literature on uncertainty associated with noisy observations? the following discussion draws on the evolution of my own thinking, as well as on the policy actions, including the announced tilts in policy and the text of the announcements that accompanied policy actions. i pick up this episode in the middle of 1996, when i joined the board. it seems to me that initially monetary policy was consistent with a backward - looking taylor rule ( although that is sometimes difficult to distinguish from a forward - looking taylor rule ). we were faced with two surprises : faster - than - expected growth ( resulting in a higher - than - expected estimated output gap ) and lower - than - expected inflation. these had offsetting effects on the nominal funds rate, yielding a nearly unchanged policy until the fall of 1998 and a policy that closely tracked the taylor rule prescription, at least allowing for updates of the estimated unemployment or output gaps along the way. alternatively, this policy could be viewed as allowing a passive rise in the real rate that turned out to be well calibrated to the rise in the output gap. as the episode progressed, more questions were raised - both inside and outside the federal reserve about the values of the nairu and trend growth. the staff continually adjusted its estimates of these parameters in response to incoming data. in the fall of 1998, monetary policy responded both to the financial market distress and to the abrupt change in the forecast for growth ( and hence utilization rates ) in the united states. i put more weight on the forecast and less on recent observations in the context of a taylor rule, a stance i thought was justified by the abrupt change in the forecast and by the unusually sharp contrast between the forecast and the still - strong incoming data. once it became apparent that the us economy was maintaining its momentum despite weaker foreign growth and that financial markets had returned toward normal, the growing uncertainty about the output gap - reflecting the continuing contradiction of declining inflation and rising output gaps made monetary policymakers cautious about aggressively reversing their policy actions. but through early 1999 we remained somewhat concerned about the degree of recovery in both financial markets and foreign economies. the net result was that the nominal funds rate remained constant during this phase, instead of tightening in line with the taylor rule prescription. in effect, policymakers could be interpreted as attenuating their response to the unemployment and output gap in

in terms of observables. put simply, policy authorities are mortals and hence are unable to observe unobservables. second, given that we don ’ t know the true model, policymakers might look at simple rules rather than try to derive optimal rules for guidance. this leads me to question the practical significance of certainty equivalence, which requires that policymakers know the true model, use an optimal rule, and update their optimal estimate of the nairu based on the true model. i draw the following conclusions from this research. first, policymakers should continuously update their estimates of the nairu and the output gap, using all available information, particularly the realizations of unemployment, output, and inflation. such updating will not entirely erase the problems associated with noisy observations, but it will mitigate them. in my view, policymakers today update their estimates of the output gap and the nairu more systematically and more frequently than they once did. this view suggests some caution in deriving the degree of attenuation from historical evidence of revisions to the nairu and potential output. second, policymakers should adjust the aggressiveness of their response to the gaps between actual and target variables in light of the uncertainty about their measurement. specifically, policymakers should attenuate their response to movements in the unemployment or output gap. there is an important complication in applying this principle. simulation results suggest that the optimal response to the output gap in the absence of uncertainty might be considerably more aggressive than the parameter in the taylor rule. the attenuation might therefore result in a response parameter closer to or lower than the taylor rule value. third, the literature is less clear about whether policymakers should offset any attenuation in the response to the output gap with a more aggressive response to movements in realized inflation. my instinct tells me that, as policy becomes less preemptive, it should become more aggressively reactive. taking the second and third conclusions together, the relative weights on the gap variable and inflation should vary, depending on the degree of uncertainty about the output gap. the higher coefficient on the inflation rate might be justified by the fact that inflation has become a better indicator of the excess demand compared with the output gap when there is heightened uncertainty about the measurement of the output gap. the focus of the literature has been on uncertainty about the unemployment or output gap, but a shift in trend productivity growth also results in uncertainty about the equilibrium real interest rate. in this case, a taylor - type rule