Monetary policy, parameter uncertainty and welfare

This paper derives optimal robust monetary policy in a standard microfounded new Keynesian model with uncertainty about the degree of price stickiness and the autocorrelation of the cost-push shock. The uncertain degree of price stickiness spills over to the endogenous objective function pursued by the central bank. In a min–max approach, the model is solved under discretion and under a Taylor rule which implements the optimal robust equilibrium under discretion. It is shown that with a welfare-based loss function, robust optimal monetary policy can neutralize the uncertainty surrounding the relative weight to assign to output-gap stabilization. Moreover, welfare improves when the endogeneity of the loss function is recognized by the central bank. Under discretion, the central bank reacts more aggressively to uncertainty about the degree of price stickiness and the autocorrelation of the cost-push shock. On the other hand, if the central bank implements the optimal discretionary robust equilibrium with a Taylor rule, under uncertainty the interest rate reacts to inflation in a less aggressive way.