More or less aggressive? Robust monetary policy in a New Keynesian model with financial distress

Rafael Gerke, Felix Hammermann and Vivien Lewis

No 2009,23, Discussion Paper Series 1: Economic Studies from Deutsche Bundesbank

Abstract: This paper investigates the optimal monetary policy response to a shock to collateral when policymakers act under discretion and face model uncertainty. The analysis is based on a New Keynesian model where banks supply loans to transaction constrained consumers. Our results confirm the literature on model uncertainty with respect to a cost-push shock. Insuring against model misspecification leads to a more aggressive policy response. The same is true for a shock to collateral. A preference for robustness leads to a more aggressive policy. Increasing the weight attached to interest rate smoothing raises the degree of aggressiveness. Our results indicate that a preference for robustness crucially depends on the way different types of disturbances affect the economy: in the case of a shock to collateral the policymaker does not need to be as much worried about model misspecification as in the case of a conventional cost-push shock.

Keywords: Optimal monetary policy; discretion; model uncertainty; banking; collateral (search for similar items in EconPapers)
JEL-codes: E32 E44 E58 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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