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Financial frictions and robust monetary policy in the models of New Keynesian framework

Ekaterina Pirozhkova ()

No 1701, BCAM Working Papers from Birkbeck Centre for Applied Macroeconomics

Abstract: In this paper I study how financial frictions affect robustness of monetary policy in DSGE models in the case of model uncertainty. The types of frictions I consider are financial accelerator and collateral constraints. Modeling monetary policy in terms of optimal interest rate rules, I find that welfare-maximizing policies for the models with financial frictions are robust to model uncertainty. Policy rule optimal for the basic New Keynesian model is not robust. Thereby I show that when there is uncertainty about what type of frictions is at work, a policymaker exposes economy to risks of significant welfare losses by using a reference model without frictions as economy representation. Using fault tolerance approach I find that modified policy rule optimal for the basic New Keynesian model is robust when it allows to respond to fluctuations in output.

Keywords: optimal monetary policy rules; financial frictions; DSGE models; robustness. (search for similar items in EconPapers)
JEL-codes: E32 E37 E44 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
Date: 2017-02
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http://www.bbk.ac.uk/ems/research/BirkCAM/working-papers/BCAM1701.pdf First version, 2017 (application/pdf)

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