Monetary Policy with Parameter Uncertainty in Small-Open Economy

Guido Traficante

International Economic Journal, 2018, vol. 32, issue 1, 120-131

Abstract: This paper computes optimal robust monetary policy in a new Keynesian small-open economy model with Knightian uncertainty about the degree of price stickiness and the elasticity of substitution between domestic and foreign goods. Due to the simple model structure used in the paper, I can derive analytical results for the min–max solution under discretion and assess how a robust optimal Taylor rule must be set in small-open economy. I find that, in an optimal robust discretionary equilibrium, the central bank should assume that the degree of price stickiness and the elasticity of substitution between domestic and foreign goods take on their highest numerical values. In terms of interest rate setting, if the optimal discretionary robust equilibrium is implemented with a Taylor rule, the policy rate should react to inflation in a less aggressive way than in the case of complete information.

Date: 2018
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DOI: 10.1080/10168737.2018.1451551

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