Robust Monetary Policy with the Cost Channel
Recent research argues that model uncertainty leads the central bank to adjust interest rates stronger to exogenous disturbances than under certainty. This paper investigates whether the introduction of a cost channel of monetary transmission, whose presence is empirically supported, changes the impact of model uncertainty on interest rate setting. The model is simple enough to facilitate an analytical solution. I find that the presence of the cost channel dampens the effect of model uncertainty on interest rate setting and can offset the activist policy stance. A richer model that allows for persistent supply and demand shocks corroborates these findings. Copyright (c) The London School of Economics and Political Science 2008.
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Volume (Year): 76 (2009)
Issue (Month): 303 (07)
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