DP4805 Robust Monetary Policy in the New-Keynesian Framework
|Author(s):||Kai Leitemo, Ulf Söderström|
|Publication Date:||December 2004|
|Keyword(s):||Knightian uncertainty, min-max policies, model uncertainty, robust control|
|JEL(s):||E52, E58, F41|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=4805|
We study the effects of model uncertainty in a simple New-Keynesian model using robust control techniques. Due to the simple model structure, we are able to find closed-form solutions for the robust control problem, analysing both instrument rules and targeting rules under different timing assumptions. In all cases but one, an increased preference for robustness makes monetary policy respond more aggressively to cost shocks but leaves the response to demand shocks unchanged. As a consequence, inflation is less volatile and output is more volatile than under the non-robust policy. Under one particular timing assumption, however, increasing the preference for robustness has no effect on the optimal targeting rule (nor on the economy).