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Robustness in monetary policymaking: a case for the Friedman rule

Juha Kilponen () and Kai Leitemo

No 4/2006, Research Discussion Papers from Bank of Finland

Abstract: Inflation targeting involves using all available information in stabilizing inflation around some target rate (Svensson, 2003). Inflation is typically at the very end of the transmission mechanism and hence its determination is subject to much model uncertainty which the central bank will want to guard against using robust policies. Such robustness comes however with the cost of increased social loss under the most likely description of the economy. We show that with a sufficiently high degree of model uncertainty, adherence to the Friedman rule of increasing the money stock by k percent will be superior as the price paid for robustness is smaller. Key words: policy robustness, money growth targeting, inflation targeting, Friedman rule JEL classification numbers: E42, E52, E58, E61

Date: 2006-02-01
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