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Robust Control and Persistence in the New Keynesian Economy

Listed author(s):
  • Michael Paetz


Since Keynes no economist would deny that expectations under uncer- tain conditions matter for the conduct of monetary policy, but still opin- ions about their formation are diverse. We build a hybrid New Keynesian Framework to analyze the influence of model uncertainty on optimal in- terest rates under di¤erent degrees of rational forward-looking behavior, using recently developed robust control techniques. Impulse response functions illustrate that uncertainty seems to be a rationale for more aggressive interest rate reactions, but also suggest that the degree of forward-looking behavior seems to be more important than an appro- priate fear about the misspecification of a given model. Furthermore, we argue that assuming to control inflation through expectations is a policy on the razor's edge, since robust expectations overestimate shock impacts. This questions the gains from commitment under uncertainty.

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Paper provided by Hamburg University, Department of Economics in its series Quantitative Macroeconomics Working Papers with number 20711.

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Date of creation: Oct 2007
Handle: RePEc:ham:qmwops:20711
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