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Imperfect Credibility and Robust Monetary Policy

  • Richard Dennis

This paper studies the behavior of a central bank that seeks to conduct policy optimally while having imperfect credibility and harboring doubts about its model. Taking the Smets-Wouters model as the central bank’s approximating model, the paper’s main findings are as follows. First, a central bank’s credibility can have large consequences for how policy responds to shocks. Second, central banks that have low credibility can benefit from a desire for robustness because this desire motivates the central bank to follow through on policy announcements that would otherwise not be time-consistent. Third, even relatively small departures from perfect credibility can produce important declines in policy performance. Finally, as a technical contribution, the paper develops a numerical procedure to solve the decision-problem facing an imperfectly credible policymaker that seeks robustness.

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File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2013-10/68_dennis.pdf
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Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2013-68.

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Length: 35 pages
Date of creation: Oct 2013
Date of revision:
Handle: RePEc:een:camaaa:2013-68
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  1. Andrew Levin & Volker Wieland & John Williams, 2000. "The Performance Of Forecast-Based Monetary Policy Rules Under Model Uncertainty," Computing in Economics and Finance 2000 203, Society for Computational Economics.
  2. Richard Dennis & Kai Leitemo & Ulf Soderstrom, 2006. "Methods for Robust Control," 2006 Meeting Papers 493, Society for Economic Dynamics.
  3. Thomas J. Sargent & Riccardo Colacito & Lars P. Hansen & Timothy Cogley, 2008. "Robustness and US Monetary," 2008 Meeting Papers 228, Society for Economic Dynamics.
  4. Andrea Tambalotti & Ernst Schaumburg, 2004. "An Investigation of the Gains from Commitment in Monetary Policy," Econometric Society 2004 North American Summer Meetings 282, Econometric Society.
  5. Davide Debortoli & Ricardo Nunes, 2007. "Loose commitment," International Finance Discussion Papers 916, Board of Governors of the Federal Reserve System (U.S.).
  6. Richard Dennis & Ulf Soderstrom, 2002. "How important is precommitment for monetary policy?," Working Paper Series 2002-10, Federal Reserve Bank of San Francisco.
  7. 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.
  8. Miles S. Kimball & Michael Woodford, 1994. "The quantitative analysis of the basic neomonetarist model," Proceedings, Federal Reserve Bank of Cleveland, pages 1241-1289.
  9. Hansen, Lars Peter & Sargent, Thomas J., 2012. "Three types of ambiguity," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 422-445.
  10. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination in Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
  11. Dennis, Richard, 2010. "How robustness can lower the cost of discretion," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 653-667, September.
  12. Martin Bodenstein & James Hebden & Ricardo Nunes, 2010. "Imperfect credibility and the zero lower bound on the nominal interest rate," International Finance Discussion Papers 1001, Board of Governors of the Federal Reserve System (U.S.).
  13. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  14. Richard Dennis, 2005. "Robust control with commitment: a modification to Hansen-Sargent," Working Paper Series 2005-20, Federal Reserve Bank of San Francisco.
  15. repec:cup:cbooks:9780521441964 is not listed on IDEAS
  16. Hansen, Lars Peter & Sargent, Thomas J. & Wang, Neng E., 2002. "Robust Permanent Income And Pricing With Filtering," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 40-84, February.
  17. Kenneth Kasa, 1999. "Model uncertainty, robust policies, and the value of commitment," Working Paper Series 99-14, Federal Reserve Bank of San Francisco.
  18. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  19. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  20. repec:cup:cbooks:9780521337809 is not listed on IDEAS
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