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Infrequent Changes of the Policy Target: Robust Optimal Monetary Policy under Ambiguity

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  • Shin-ichi Fukuda

    (Faculty of Economics, University of Tokyo)

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    Abstract

    In many countries, the monetary policy instrument sometimes remains unchanged for a long period and shows infrequent responses to exogenous shocks. The purpose of this paper is to provide a new explanation on why the central bank's policy instrument remains unchanged. In the analysis, we explore how uncertainty on the private agents' expectations affects robust optimal monetary policy. We apply the Choquet expected decision theory to a new Keynesian model. A main result is that the policymaker may frequently keep the interest rate unchanged even when exogenous shocks change output gaps and inflation rates. This happens because a change of the interest rate increases additional uncertainty for the policymaker. To the extent that the policymaker has uncertainty aversion, it can therefore be optimal for the policymaker to maintain an unchanged policy stance for some significant periods and to make discontinuous changes of the target rate. Our analysis departs from previous studies in that we determine an optimal monetary policy rule that allows time-variant feedback parameters in a Taylor rule. We show that if the policymaker has small uncertainty aversion, the calibrated optimal stop-go policy rule can predict actual target rates of FRB and ECB reasonably well.

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    Bibliographic Info

    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-863.

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    Length: 33 pages
    Date of creation: Sep 2012
    Date of revision:
    Handle: RePEc:tky:fseres:2012cf863

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    1. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(3), pages 581-604, April.
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    12. 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, Board of Governors of the Federal Reserve System (U.S.) 2000-28, Board of Governors of the Federal Reserve System (U.S.).
    13. Gilboa, Itzhak, 1987. "Expected utility with purely subjective non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 16(1), pages 65-88, February.
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