Does Model Uncertainty Justify Conservatism? Robustness and the Delegation of Monetary Policy

Peter Tillmann

The B.E. Journal of Macroeconomics, 2009, vol. 9, issue 1, 28

Abstract: This paper analyzes the rationale for delegating monetary policy to an inflation-averse central banker when there is a preference for robustness of optimal policy with respect to misspecifications of the underlying model of the economy. We use a simple New Keynesian model to show how the optimal output gap weight in the central bank's objective function depends on the degree of model uncertainty. In particular, we show numerically that the rationale for appointing a conservative central bank prevails even if the central bank is concerned about the robustness of policy with respect to model misspecifications. Moreover, we find that the central bank should put more relative weight on inflation stabilization if the degree of uncertainty increases. Interestingly, if the degree of uncertainty is large, monetary policy should be delegated to a conservative central banker even in the absence of shock persistence.

Keywords: optimal monetary policy; delegation; robust control; New Keynesian model; stabilization bias (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (4)

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DOI: 10.2202/1935-1690.1564

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