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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. 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.
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  5. Alexei Onatski & James H. Stock, 2000. "Robust Monetary Policy Under Model Uncertainty in a Small Model of the U.S. Economy," NBER Working Papers 7490, National Bureau of Economic Research, Inc.
  6. Pierpaolo Benigno, 2008. "Price stability with imperfect financial integration," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  7. 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.
  8. Richard Dennis & Kai Leitemo & Ulf Söderström, 2007. "Monetary policy in a small open economy with a preference for robustness," Working Paper Series 2007-04, Federal Reserve Bank of San Francisco.
  9. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
  10. Alexei Onatski & Noah Williams, 2003. "Modeling Model Uncertainty," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1087-1122, 09.
  11. Takeshi Kimura & Takushi Kurozumi, 2003. "Optimal monetary policy in a micro-founded model with parameter uncertainty," Finance and Economics Discussion Series 2003-67, Board of Governors of the Federal Reserve System (U.S.).
  12. Keith Kuester & Volker Wieland, 2010. "Insurance Policies for Monetary Policy in the Euro Area," Journal of the European Economic Association, European Economic Association, vol. 8(4), pages 872-912, 06.
  13. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," Levine's Bibliography 506439000000000394, UCLA Department of Economics.
  14. Söderström, Ulf, 1999. "Monetary policy with uncertain parameters," Working Paper Series 83, Sveriges Riksbank (Central Bank of Sweden).
  15. Rustem, Berc & Wieland, Volker & Zakovic, Stan, 2005. "Stochastic optimization and worst-case analysis in monetary policy design," CFS Working Paper Series 2005/14, Center for Financial Studies (CFS).
  16. 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.
  17. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: A General Approach," Levine's Bibliography 666156000000000246, UCLA Department of Economics.
  18. Richard Dennis & Kai Leitemo & Ulf Söderström, 2006. "Methods for robust control," Working Paper Series 2006-10, Federal Reserve Bank of San Francisco.
  19. 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.
  20. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
  21. Kai Leitemo & Ulf Soderstrom, 2001. "Simple monetary policy rules and exchange rate uncertainty," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  22. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  23. Moessner, Richhild, 2005. "Optimal discretionary policy and uncertainty about inflation persistence," Working Paper Series 0540, European Central Bank.
  24. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
  25. Leitemo, Kai & Söderström, Ulf, 2004. "Robust Monetary Policy in the New-Keynesian Framework," CEPR Discussion Papers 4805, C.E.P.R. Discussion Papers.
  26. 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.
  27. Laurence Ball, 1990. "Credible Disinflation with Staggered Price Setting," NBER Working Papers 3555, National Bureau of Economic Research, Inc.
  28. N. Gregory Mankiw, 2000. "The Inexorable and Mysterious Tradeoff Between Inflation and Unemployment," Harvard Institute of Economic Research Working Papers 1905, Harvard - Institute of Economic Research.
  29. Lars Peter Hansen & Thomas J. Sargent, 2007. "Introduction to Robustness," Introductory Chapters, Princeton University Press.
  30. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September.
  31. 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.
  32. Richard Clarida & Jordi Gali & Mark Gertler, 2002. "A Simple Framework for International Monetary Policy Analysis," NBER Working Papers 8870, National Bureau of Economic Research, Inc.
  33. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers.
  34. 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.
  35. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  36. 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.
  37. 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.
  38. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May.
  39. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
  40. 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.
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