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A positive theory of monetary policy and robust control

  • Juha Kilponen

    (Bank of Finland)

This paper applies the robust control approach to a simple positive theory of monetary policy, when the central bank’s model of the economy is subject to misspecifications. It is shown that a central bank should react more aggressively to supply shocks when the model misspecifications grow larger. Moreover, the model misspecifications aggravate the inflation bias and a trade-off between output stabilisation and inflation worsens when the uncertainty surrounding the central bank’s model increases. This implies that the larger the model misspecifications are, the more inflation-averse the central bank should be.

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File URL: http://128.118.178.162/eps/mac/papers/0404/0404014.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 0404014.

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Length: 26 pages
Date of creation: 19 Apr 2004
Date of revision:
Handle: RePEc:wpa:wuwpma:0404014
Note: Type of Document - pdf; pages: 26
Contact details of provider: Web page: http://128.118.178.162

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  1. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  2. Lars E.O. Svensson, 1995. "Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts," NBER Working Papers 5251, National Bureau of Economic Research, Inc.
  3. 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.
  4. Lars E.O. Svensson, 2002. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Working Papers 118, Princeton University, Department of Economics, Center for Economic Policy Studies..
  5. Peter von zur Muehlen, 2001. "Activist vs. non-activist monetary policy: optimal rules under extreme uncertainty," Finance and Economics Discussion Series 2001-02, Board of Governors of the Federal Reserve System (U.S.).
  6. Robert J. Tetlow & Peter von zur Muehlen, 2000. "Robust monetary policy with misspecified models: does model uncertainty always call for attenuated policy?," Finance and Economics Discussion Series 2000-28, Board of Governors of the Federal Reserve System (U.S.).
  7. 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.
  8. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  9. Lars Peter Hansen & Thomas J. Sargent & Thomas D. Tallarini Jr., 1997. "Robust Permanent Income and Pricing," Levine's Working Paper Archive 596, David K. Levine.
  10. repec:cup:macdyn:v:6:y:2002:i:1:p:111-44 is not listed on IDEAS
  11. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  12. Alexei Onatski & Noah Williams, 2002. "Modeling model uncertainty," Discussion Papers 0203-05, Columbia University, Department of Economics.
  13. Robin M. Hogarth & Hillel J. Einhorn, 1990. "Venture Theory: A Model of Decision Weights," Management Science, INFORMS, vol. 36(7), pages 780-803, July.
  14. 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.
  15. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  16. 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.
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