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Robust Control Rules to Shield Against Indeterminacy

  • Nicoletta Batini
  • Paul Levine

We address robustness of inflation targeting rules in a New Keynesian model using two approaches. Firstly we use the Hansen-Sargent method, borrowed from the control theory literature, to design robust rules on the basis of the policymaker playing a game against malign nature. This welfare-based approach is intended to deal with worst case scenarios, but does not directly address stability robustness. Furthermore, in the case of forward-looking systems, it does not address indeterminacy robustness; thus a system may have good stability properties, but a small parameter change could lead to indeterminacy. Secondly, we address this latter issue by imposing a probability distribution on problematic parameters, and investigate both the probability of instability and the probability of indeterminacy of the robust rule. For comparison, we apply the same idea to inflation forecast based rules, which have the potential to perform well provided that there is enough interest rate smoothing and that the forecast horizon is not too far ahead

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 339.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:339
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  1. Juillard, Michel & Karam, Philippe & Laxton, Douglas & Pesenti, Paolo, 2006. "Welfare-based monetary policy rules in an estimated DSGE model of the US economy," Working Paper Series 0613, European Central Bank.
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  7. Nicoletta Batini & Joseph Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Discussion Papers 08, Monetary Policy Committee Unit, Bank of England.
  8. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
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  11. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  14. Ignazio Angeloni & Gunter Coenen & Frank Smets, 2003. "Persistence, The Transmission Mechanism And Robust Monetary Policy," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 527-549, November.
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  21. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
  22. Efrem Castelnuovo, 2003. "Taylor Rules and Interest Rate Smoothing in the US and EMU," Macroeconomics 0303002, EconWPA.
  23. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 911-949, June.
  24. Ryan Banerjee & Nicoletta Batini, 2003. "UK Consumers’ Habits," Discussion Papers 13, Monetary Policy Committee Unit, Bank of England.
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