Robust Monetary Policy in the New-Keynesian Framework

IGIER Working Paper No. 273

18 Pages Posted: 7 Dec 2004

See all articles by Kai Leitemo

Kai Leitemo

Norwegian School of Management

Ulf Söderström

Central Bank of Sweden - Research Department

Multiple version iconThere are 3 versions of this paper

Date Written: November 2004

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, analyzing 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 the 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, minmax policies

JEL Classification: E52, E58, F41

Suggested Citation

Leitemo, Kai and Söderström, Ulf, Robust Monetary Policy in the New-Keynesian Framework (November 2004). IGIER Working Paper No. 273, Available at SSRN: https://ssrn.com/abstract=627350 or http://dx.doi.org/10.2139/ssrn.627350

Kai Leitemo

Norwegian School of Management ( email )

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Ulf Söderström (Contact Author)

Central Bank of Sweden - Research Department ( email )

Stockholm, 103 37
Sweden
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HOME PAGE: http://www.riksbank.se/research/soderstrom