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Robust Monetary Policy in a Small Open Economy

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  • Leitemo, Kai
  • Söderström, Ulf

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 for the optimal robust policy rule, and we separately analyse 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.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5071.

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Date of creation: May 2005
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Handle: RePEc:cpr:ceprdp:5071

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Keywords: Knightian uncertainty; min-max policies; model uncertainty; robust control;

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References

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  1. Richard Dennis & Kai Leitemo & Ulf Söderström, 2007. "Monetary policy in a small open economy with a preference for robustness," Working Paper Series 2007-04, Federal Reserve Bank of San Francisco.
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