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Robust control and central banking behaviour

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  • Olalla, Myriam García
  • Gómez, Alejandro Ruiz
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    Abstract

    This paper seeks to explain the recent behaviour of the two main central banks in the recent financial crisis, applying a robust control tool through a Neo-Keynesian monetary policy model. The direct forbearer of this paper is the Giordani and Söderlind (2004) study. It begins with the origin, purpose and theoretical grounds of robust control, indicating that it is one way to face model uncertainty, as an alternative to the Bayesian approach. In the middle section, we seek to obtain the course of the model's main variables: interest rates, inflation and output. The model constructor also wants the participating agents to have the same doubts that he has regarding its validity; therefore, robust control is considered as a "fine-tuning" of the rational expectations approach. The impulse-response functions are obtained, with the monetary authority acting as a Stackelberg-type leader, affected by a perturbation on the supply side. The two relevant equilibria are obtained and compared in robust control with dynamic economy (the reference equilibrium and the worst possible case equilibrium) with that obtained when operating with rational expectations. The alternative course for the reference model set forth in the paper by Dennis (2008) is also analysed. We mainly find that the different results depend on the behaviour of the law of motion of the state variables, specifically the shadow prices that influence the private sector's expectations. Lastly, the paper relates the recent monetary policy performance when facing the financial crisis that began in the summer of 2007.

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    Bibliographic Info

    Article provided by Elsevier in its journal Economic Modelling.

    Volume (Year): 28 (2011)
    Issue (Month): 3 (May)
    Pages: 1265-1278

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    Handle: RePEc:eee:ecmode:v:28:y:2011:i:3:p:1265-1278

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    Web page: http://www.elsevier.com/locate/inca/30411

    Related research

    Keywords: Robustness Model uncertainty Commitment;

    References

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    1. Hansen, Lars Peter & Sargent, Thomas J. & Wang, Neng E., 2002. "Robust Permanent Income And Pricing With Filtering," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 40-84, February.
    2. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules Under Model Uncertainty," American Economic Review, American Economic Association, vol. 93(3), pages 622-645, June.
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    9. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 111-144, February.
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    Cited by:
    1. Lars Peter Hansen & Thomas J. Sargent, 2012. "Three Types of Ambiguity," Working Papers 2012-006, Becker Friedman Institute for Research In Economics.

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