Three factors of uncertainty come into the picture: -  first, there is by essence a high degree of uncertainty surrounding the assessment of misalignments, related to their equilibrium prices and the channels of transmission to the real economy;  -  second, central banks have to keep in mind the balance of risks facing the economy: a monetary policy action that would reduce the risk of a large loss in the future might be very costly for the economy in the short run;  -  third, the effects of monetary policy decisions on asset prices are very uncertain. •  The announcement of a systematic reaction could therefore lead to moral hazard and undermine the central bank’s anti-inflationist credibility, which is its most precious asset. Moreover, the single interest rate policy cannot be geared simultaneously towards two potentially conflicting objectives. c.  Be aggressive or experiment  There may be two cases where gradualism is not the systematic guideline. •  Worst-case outcomes may best be prevented by following policy rules that are rather aggressive in responding to inflation deviations from target. •  A more aggressive policy rule may generate more information, which would improve the learning of the central bank and thereby future policy performance. But the learning process might be costly since it could generate increased volatility. 2. Some approaches to address uncertainty  a. Rely on monetary policy rules  •  Simple monetary policy rules (like the Taylor rule) may perform well in many different models.
2)  The Eurosystem faces general but also specific sources of uncertainty  •  As regards the general sources of uncertainty, one can mention uncertainties related to:  •  II  -  macroeconomic data, which may be unobservable (output gap) or subject to revisions (GDP);  -  the nature and the persistence of shocks: e.g. oil and commodities shocks, the degree of pass-through to prices, etc. ;  -  the transmission of monetary policy to the real economy, since Milton Friedman showed that “monetary policy works with long and variable lags”;  -  the potential asset prices misalignments and wealth effects. But uncertainty may be more pronounced in the case of the euro area: -  the available time series are short;  -  the euro area has potentially experienced a regime shift à la Lucas;  -  the euro is a catalyst for structural changes. How to deal with uncertainty? The economic literature has proposed some monetary policy guidelines (II/1) and approaches (II/2) to address uncertainty. BIS Review 63/2006  1  1)  Monetary policy guidelines  a. Disregard uncertainty  •  If the uncertainty is related to data or shocks (the so called “additive” uncertainty), it may be optimal to take decisions as if there were no uncertainty at all.