Research Discussion Papers, Bank of Finland
No 31/2004:
Robust monetary policy in the New-Keynesian framework
Kai Leitemo ()
and Ulf Söderström ()
Abstract: 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 a 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).
Keywords: Knightian uncertainty; model uncertainty; robust control; min-max policies; (follow links to similar papers)
JEL-Codes: E52; E58; F41; (follow links to similar papers)
26 pages, October 13, 2004
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