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Robust Monetary Policy in a Small Open Economy

  • Leitemo, Kai
  • Söderström, Ulf

This paper studies how a central bank’s preference for robustness against model misspecification affects the design of monetary policy in a New-Keynesian model of a small open economy. Due to the simple model structure, we are able to solve analytically for the optimal robust policy rule, and we separately analyse the effects of robustness against misspecification concerning the determination of inflation, output and the exchange rate. We show that an increased central bank preference for robustness makes monetary policy respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5071.

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Date of creation: May 2005
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Handle: RePEc:cpr:ceprdp:5071
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  1. Söderström, Ulf, 1999. "Monetary policy with uncertain parameters," Working Paper Series 83, Sveriges Riksbank (Central Bank of Sweden).
  2. Kai Leitemo & Ulf Soderstrom, 2004. "Robust Monetary Policy in the New-Keynesian Framework," Working Papers 273, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  4. Volker Wieland & Keith Kuester, 2005. "Insurance Policies for Monetary Policy in the Euro Area," Computing in Economics and Finance 2005 100, Society for Computational Economics.
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  6. 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.
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  9. Kimura, Takeshi & Kurozumi, Takushi, 2007. "Optimal monetary policy in a micro-founded model with parameter uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 31(2), pages 399-431, February.
  10. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," Levine's Bibliography 506439000000000394, UCLA Department of Economics.
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  12. Onatski, Alexei & Williams, Noah, 2002. "Modeling model uncertainty," Working Paper Series 0169, European Central Bank.
  13. Giordani, Paolo & Söderlind, Paul, 2002. "Solution of Macromodels with Hansen-Sargent Robust Policies: Some Extensions," SSE/EFI Working Paper Series in Economics and Finance 499, Stockholm School of Economics, revised 15 May 2003.
  14. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
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  18. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: A General Approach," Levine's Bibliography 666156000000000246, UCLA Department of Economics.
  19. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
  20. N. Gregory Mankiw, 2000. "The Inexorable and Mysterious Tradeoff Between Inflation and Unemployment," NBER Working Papers 7884, National Bureau of Economic Research, Inc.
  21. Richard Dennis & Kai Leitemo & Ulf Soderstrom, 2006. "Methods for Robust Control," 2006 Meeting Papers 493, Society for Economic Dynamics.
  22. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  23. Dennis, Richard & Leitemo, Kai & Söderström, Ulf, 2007. "Monetary Policy in a Small Open Economy with a Preference for Robustness," CEPR Discussion Papers 6067, C.E.P.R. Discussion Papers.
  24. Clarida, Richard & Galí, Jordi & Gertler, Mark, 2002. "A Simple Framework for International Monetary Policy Analysis," CEPR Discussion Papers 3355, C.E.P.R. Discussion Papers.
  25. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
  26. Walsh, Carl E, 2004. "Robustly Optimal Instrument Rules and Robust Control: An Equivalence Result," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 1105-13, December.
  27. Batini, Nicoletta & Justiniano, Alejandro & Levine, Paul & Pearlman, Joseph, 2006. "Robust inflation-forecast-based rules to shield against indeterminacy," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1491-1526.
  28. Kai Leitemo & Ulf Soderstrom, 2001. "Simple monetary policy rules and exchange rate uncertainty," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  29. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, 02.
  30. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
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  34. Moessner, Richhild, 2005. "Optimal discretionary policy and uncertainty about inflation persistence," Working Paper Series 0540, European Central Bank.
  35. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  36. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  37. Walsh, Carl E., 2005. "Endogenous objectives and the evaluation of targeting rules for monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 889-911, July.
  38. Lars Peter Hansen & Thomas J. Sargent, 2007. "Introduction to Robustness," Introductory Chapters, Princeton University Press.
  39. Peter Tillmann, 2009. "Optimal Monetary Policy with an Uncertain Cost Channel," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(5), pages 885-906, 08.
  40. Lars Peter Hansen & Thomas J. Sargent, 2001. "Acknowledging Misspecification in Macroeconomic Theory," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 519-535, July.
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