Monetary Policy in a Small Open Economy with a Preference for Robustness

Söderström, Ulf, Kai Leitemo and ,
Authors registered in the RePEc Author Service: Ulf Söderström and Richard Dennis

No 6067, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We use robust control techniques to study the effects of model uncertainty on monetary policy in an estimated, semi-structural, small-open-economy model of the U.K. Compared to the closed economy, the presence of an exchange rate channel for monetary policy not only produces new trade-offs for monetary policy, but it also introduces an additional source of specification errors. We find that exchange rate shocks are an important contributor to volatility in the model, and that the exchange rate equation is particularly vulnerable to model misspecification, along with the equation for domestic inflation. However, when policy is set with discretion, the cost of insuring against model misspecification appears reasonably small.

Keywords: Model misspecification; Model uncertainty; Robust control (search for similar items in EconPapers)
JEL-codes: E52 E61 F41 (search for similar items in EconPapers)
Date: 2007-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Related works:
Working Paper: Monetary policy in a small open economy with a preference for robustness (2007)
Working Paper: Monetary Policy in a Small Open Economy with a Preference for Robustness (2006)
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