Research Discussion Papers, Bank of Finland
No 20/2005:
Robust monetary policy in a small open economy
Kai Leitemo ()
and Ulf Söderström ()
Abstract: This paper studies how a central bank’s preference for
robustness against model misspecification affects the design of monetary
policy in a New-Keynesian model of a small open economy. Due to the simple
model structure, we are able to solve analytically solve the optimal robust
policy rule, and separately ana-lyze the effects of robustness against
misspecification concerning the determination of inflation, output and the
exchange rate. We show that an increased central bank preference for
robustness makes monetary policy respond more aggressively or more
cautiously to shocks, depending on the type of shock and the source of
misspecification.
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)
58 pages, October 11, 2005
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