Research Discussion Papers, Bank of Finland
No 5/2004:
Robust expectations and uncertain models – A robust control approach with application to the New Keynesian economy
Juha Kilponen ()
Abstract: This paper extends Svensson and Woodford’s (2003) partial
information framework by allowing the private agents to achieve robustness
against incomplete information about the structure of the economy by
distorting their expectations in a particular direction. It shows how a
linear rational expectations equilibrium under concern for robustness can
be solved by exploiting the recursive structure of the problem and
appropriately modifying the Bellman equations in their framework. The
standard Kalman filter is then used for information updating under
imperfect measurement of the state variables. The standard New Keynesian
model is used for illustrating how concern for modelling errors interacts
with imperfect information. Agents achieve robustness by simultaneously
over-estimating the persistence of exogenous shocks, but under-estimating
the policy response to the output gap. This under-estimation, combined with
imperfect measurement, leads to larger and more persistent responses of
private consumption to government expenditure shocks under robust
expectations.
Keywords: expectations; robust control; model uncertainty; monetary policy; imperfect information; (follow links to similar papers)
JEL-Codes: C61; D81; E52; (follow links to similar papers)
46 pages, January 1, 2004
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