Research Discussion Papers, Bank of Finland
A positive theory of monetary policy and robust control
Abstract: This paper applies the robust control approach to a simple
positive theory of monetary policy, when the central bank’s model of the
economy is subject to misspecifications. It is shown that a central bank
should react more aggressively to supply shocks when the model
misspecifications grow larger. Moreover, the model misspecifications
aggravate the inflation bias and a trade-off between output stabilisation
and inflation worsens when the uncertainty surrounding the central bank’s
model increases. This implies that the larger the model misspecifications
are, the more inflation-averse the central bank should be.
Keywords: risk-sensitivity; robust control theory; monetary policy; Brainard conservatism; model uncertainty; (follow links to similar papers)
JEL-Codes: E58; (follow links to similar papers)
30 pages, August 12, 2003
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