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Financial frictions and robust monetary policy in the models of New Keynesian framework

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  • Ekaterina Pirozhkova

    (Birkbeck, University of London)

Abstract

In this paper I study how financial frictions affect robustness of monetary policy in DSGE models in the case of model uncertainty. The types of frictions I consider are financial accelerator and collateral constraints. Modeling monetary policy in terms of optimal interest rate rules, I find that welfare-maximizing policies for the models with financial frictions are robust to model uncertainty. Policy rule optimal for the basic New Keynesian model is not robust. Thereby I show that when there is uncertainty about what type of frictions is at work, a policymaker exposes economy to risks of significant welfare losses by using a reference model without frictions as economy representation. Using fault tolerance approach I find that modified policy rule optimal for the basic New Keynesian model is robust when it allows to respond to fluctuations in output.

Suggested Citation

  • Ekaterina Pirozhkova, 2017. "Financial frictions and robust monetary policy in the models of New Keynesian framework," BCAM Working Papers 1701, Birkbeck Centre for Applied Macroeconomics.
  • Handle: RePEc:bbk:bbkcam:1701
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    References listed on IDEAS

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    Keywords

    optimal monetary policy rules; financial frictions; DSGE models; robustness.;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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