INFREQUENT CHANGES OF THE POLICY TARGET: ROBUST OPTIMAL MONETARY POLICY UNDER AMBIGUITY

Shin-ichi Fukuda ()

Global Journal of Economics (GJE), 2012, vol. 01, issue 02, 1-27

Abstract: In many countries, the monetary policy instrument sometimes remains unchanged for a long period and shows infrequent responses to exogenous shocks. The purpose of this paper is to provide a new explanation on why the central bank's policy instrument remains unchanged. In the analysis, we explore how uncertainty on the private agents' expectations affects robust optimal monetary policy. We apply the Choquet expected decision theory to a new Keynesian model. A main result is that the policymaker may frequently keep the interest rate unchanged even when exogenous shocks change output gaps and inflation rates. This happens because a change of the interest rate increases additional uncertainty for the policymaker. To the extent that the policymaker has uncertainty aversion, it can therefore be optimal for the policymaker to maintain an unchanged policy stance for some significant periods and to make discontinuous changes of the target rate. Our analysis departs from previous studies in that we determine an optimal monetary policy rule that allows time-variant feedback parameters in a Taylor rule. We show that if the policymaker has small uncertainty aversion, the calibrated optimal stop-go policy rule can predict actual target rates of FRB and ECB reasonably well.

Keywords: Uncertainty; monetary policy; New Keynesian model; Taylor rule; E40; E52; D81 (search for similar items in EconPapers)
Date: 2012
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http://www.worldscientific.com/doi/abs/10.1142/S2251361212500103
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Related works:
Working Paper: Infrequent Changes of the Policy Target: Robust Optimal Monetary Policy under Ambiguity (2012)
Working Paper: Infrequent Changes of the Policy Target: Robust Optimal Monetary Policy under Ambiguity (2012)
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DOI: 10.1142/S2251361212500103

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