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ROBUST MONETARY POLICY IN THE NEW KEYNESIAN FRAMEWORK

Published online by Cambridge University Press:  01 April 2008

KAI LEITEMO  and
ULF SÖDERSTRÖM
KAI LEITEMO*
Affiliation:
Norwegian School of Management
ULF SÖDERSTRÖM
Affiliation:
Università Bocconi
*
Address correspondence to: Kai Leitemo, Department of Economics, Norwegian School of Management (BI), Nydalsveien 37, 0442 Oslo, Norway; e-mail: kai.leitemo@bi.no.
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Abstract

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, analyzing 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 the nonrobust policy. Under one particular timing assumption, however, increasing the preference for robustness has no effect on the optimal targeting rule (nor on the economy).

Keywords

Knightian UncertaintyModel UncertaintyRobust ControlMinmax Policies
Type
ARTICLES
Information
Macroeconomic Dynamics , Volume 12 , Supplement S1: Dynamic Macroeconomic Theory , April 2008 , pp. 126 - 135
Copyright
Copyright © Cambridge University Press 2007

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References

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