The Information Effect, Policy Rule Ambiguity, and the Decomposition of Monetary Policy Surprises

I study a New Keynesian economy in which the private sector has imperfect information about both the underlying shock and the monetary policy rule. The information effect of monetary policy makes the two sources of imperfect information interact with each other. On the normative side, I show that the conventional certainty equivalence result regarding optimal monetary policy breaks down. The optimal policy rule becomes less responsive to the underlying shock, and depends on the degree of rule ambiguity. On the positive side, in a dynamic New Keynesian model calibrated to the US economy, I decompose monetary policy surprises into shock uncertainty, rule ambiguity, and the interaction effect. I find that the interaction effect accounts for more than 70 percent of the variance of monetary policy surprises.