Working Paper Abstract
290.Robust Monetary Policy in a Small Open Economyby Kai Leitemo (Norwegian School of Management) and Ulf Soderstrom (IGIER and Bocconi University)
This paper studies how a central bank’s preference for robustness againstmodel misspecification affects the design of monetary policy in a New-Keynesianmodel of a small open economy. Due to the simple model structure,we are able to solve analytically for the optimal robust policy rule, and weseparately analyze the effects of robustness against misspecification concerningthe determination of inflation, output and the exchange rate. We show thatan increased central bank preference for robustness makes monetary policyrespond more aggressively or more cautiously to shocks, depending on thetype of shock and the source of misspecification.
Keywords: Knightian uncertainty, model uncertainty, robust control, minmaxpolicies.JEL Classification: E52, E58, F41.
Download PDF version of paper
IGIER - Università Bocconi