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Robust monetary policy in the New-Keynesian framework

  • Kai Leitemo

    (Bank of Finland)

  • Ulf Söderström

    (Bank of Finland)

We study the effects of model uncertainty in a simple New-Keynesian model using robust control techniques. Due to the simple model structure, we are able to find closed-form solutions for the robust control problem, analysing both instrument rules and targeting rules under different timing assumptions. In all cases but one, an increased preference for robustness makes monetary policy respond more aggressively to cost shocks but leaves the response to demand shocks unchanged. As a consequence, inflation is less volatile and output is more volatile than under a non-robust policy. Under one particular timing assumption, however, increasing the preference for robustness has no effect on the optimal targeting rule (nor on the economy).

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File URL: http://econwpa.repec.org/eps/mac/papers/0508/0508032.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 0508032.

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Length: 26 pages
Date of creation: 31 Aug 2005
Date of revision:
Handle: RePEc:wpa:wuwpma:0508032
Note: Type of Document - pdf; pages: 26. Bank of Finland Discussion Papers 31/2004
Contact details of provider: Web page: http://econwpa.repec.org

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