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Uncertainty about the Persistence of Cost-Push Shocks and the Optimal Reaction of the Monetary Authority


  • Arnulfo Rodríguez
  • Fidel González
  • Jesús R. González García


In this paper we formalize the uncertainty about the persistence of cost-push shocks using an open economy optimal control model with Markov regime-switching and robust control. The latter is used in only one of the regimes producing relatively more persistent cost-push shocks in that regime. Conditional on being in the regime with relatively less persistence, we obtain two main results: a) underestimating the probability of switching to the regime with relatively more persistent cost-push shocks causes higher welfare losses than its overestimation; and b) the welfare losses associated with either underestimation or overestimation of such probability increase with the size of the penalty on inflation deviations from its target. Keywords: Model uncertainty, Robustness, Markov regime-switching, Monetary policy, Inflation targeting.

Suggested Citation

  • Arnulfo Rodríguez & Fidel González & Jesús R. González García, 2007. "Uncertainty about the Persistence of Cost-Push Shocks and the Optimal Reaction of the Monetary Authority," Working Papers 2007-05, Banco de México.
  • Handle: RePEc:bdm:wpaper:2007-05

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    References listed on IDEAS

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    Cited by:

    1. Andrew P Blake & Fabrizio Zampolli, 2006. "Optimal monetary policy in Markov-switching models with rational expectations agents," Bank of England working papers 298, Bank of England.

    More about this item


    Model uncertainty; Robustness; Markov regime-switching; Monetary policy; Inflation targeting;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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