MODEL UNCERTAINTY AND FINANCIAL FRICTIONS: IMPLICATIONS FOR OPTIMAL MONETARY POLICY

Zeynep Kantur () and GÜLSERİM Özcan
Additional contact information
GÜLSERİM Özcan: ��Department of Economics, Atılım University, Ankara 06830, Turkey

The Singapore Economic Review (SER), 2024, vol. 69, issue 02, 793-812

Abstract: The last decades proved that policymaking without considering uncertainty is impracticable. In an environment of uncertainty, policymakers have doubts about the policy models they routinely use. This paper focuses specifically on the situation where uncertainty on the financial side of the economy leads to misspecification in the policy model. We describe a coherent strategy for policymakers who are averse to model misspecification and analyze optimal policy design in the face of Knightian uncertainty. To do so, we augment a financial dynamic stochastic general equilibrium model with model misspecification in a simple minimax framework where the central bank plays a zero-sum game versus a hypothetical evil agent. The policy is tailored to insure against the worst-case outcomes. We show that model ambiguity on the financial side requires a passive monetary policy stance. However, if the uncertainty originates from the supply side of the economy, an aggressive response of interest rate is required. We also show the impact of an additional macroprudential tool on the dynamics of the economy.

Keywords: Model uncertainty; financial stability; optimal monetary policy; robust control; Knightian uncertainty (search for similar items in EconPapers)
JEL-codes: D81 E44 E52 E58 (search for similar items in EconPapers)
Date: 2024
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0217590822410016
Access to full text is restricted to subscribers

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:serxxx:v:69:y:2024:i:02:n:s0217590822410016

Ordering information: This journal article can be ordered from

DOI: 10.1142/S0217590822410016

Access Statistics for this article

The Singapore Economic Review (SER) is currently edited by Euston Quah

More articles in The Singapore Economic Review (SER) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().