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A positive theory of monetary policy and robust control

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  • Kilponen , Juha

    ()
    (Bank of Finland Research)

Abstract

This paper applies the robust control approach to a simple positive theory of monetary policy, when the central bank’s model of the economy is subject to misspecifications. It is shown that a central bank should react more aggressively to supply shocks when the model misspecifications grow larger. Moreover, the model misspecifications aggravate the inflation bias and a trade-off between output stabilisation and inflation worsens when the uncertainty surrounding the central bank’s model increases. This implies that the larger the model misspecifications are, the more inflation-averse the central bank should be.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0318.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 18/2003.

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Length: 30 pages
Date of creation: 12 Aug 2003
Date of revision:
Handle: RePEc:hhs:bofrdp:2003_018

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Related research

Keywords: risk-sensitivity; robust control theory; monetary policy; Brainard conservatism; model uncertainty;

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References

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  1. Giordani, Paolo & Söderlind, Paul, 2002. "Solution of Macromodels with Hansen-Sargent Robust Policies: Some Extensions," Working Paper Series in Economics and Finance 499, Stockholm School of Economics, revised 15 May 2003.
  2. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  3. Lars Hansen & Thomas Sargent & Thomas Tallarini, . "Robust Permanent Income and Pricing," GSIA Working Papers 1997-51, Carnegie Mellon University, Tepper School of Business.
  4. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
  5. Lars E.O. Svensson, 1997. "Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts," NBER Working Papers 5251, National Bureau of Economic Research, Inc.
  6. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  7. Robert J. Tetlow & Peter von zur Muehlen, 2000. "Robust monetary policy with misspecified models: does model uncertainty always call for attenuated policy?," Finance and Economics Discussion Series 2000-28, Board of Governors of the Federal Reserve System (U.S.).
  8. Peter von zur Muehlen, 2001. "Activist vs. non-activist monetary policy: optimal rules under extreme uncertainty," Finance and Economics Discussion Series 2001-02, Board of Governors of the Federal Reserve System (U.S.).
  9. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
  10. 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.
  11. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  12. Alexei Onatski & Noah Williams, 2003. "Modeling Model Uncertainty," NBER Working Papers 9566, National Bureau of Economic Research, Inc.
  13. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  14. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  15. Alexei Onatski & James H. Stock, 1999. "Robust monetary policy under model uncertainty in a small model of the U.S. economy," Proceedings, Federal Reserve Bank of San Francisco.
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Citations

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Cited by:
  1. Kilponen, Juha & Leitemo, Kai, 2006. "Robustness in monetary policymaking: a case for the Friedman rule," Research Discussion Papers 4/2006, Bank of Finland.
  2. Meixing Dai & Eleftherios Spyromitros, 2010. "Accountability And Transparency About Central Bank Preferences For Model Robustness," Scottish Journal of Political Economy, Scottish Economic Society, vol. 57(2), pages 212-237, 05.
  3. Francesco Giuli, 2007. "Robust control in a Sticky information economy," Working Papers 98, University of Rome La Sapienza, Department of Public Economics.
  4. Juha Kilponen, 2004. "Robust expectations and uncertain models – A robust control approach with application to the New Keynesian economy," GE, Growth, Math methods 0404004, EconWPA.

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