Robust Control and Persistence in the New Keynesian Economy

Michael Paetz

Quantitative Macroeconomics Working Papers from Hamburg University, Department of Economics

Abstract: Since Keynes no economist would deny that expectations under uncer- tain conditions matter for the conduct of monetary policy, but still opin- ions about their formation are diverse. We build a hybrid New Keynesian Framework to analyze the influence of model uncertainty on optimal in- terest rates under di¤erent degrees of rational forward-looking behavior, using recently developed robust control techniques. Impulse response functions illustrate that uncertainty seems to be a rationale for more aggressive interest rate reactions, but also suggest that the degree of forward-looking behavior seems to be more important than an appro- priate fear about the misspecification of a given model. Furthermore, we argue that assuming to control inflation through expectations is a policy on the razor's edge, since robust expectations overestimate shock impacts. This questions the gains from commitment under uncertainty.

Keywords: Robust Control; Knightian Uncertainty; Monetary Policy; Forward-Looking Expectations; Model Uncertainty. (search for similar items in EconPapers)
JEL-codes: C61 C68 D81 E5 E52 E58 E61 (search for similar items in EconPapers)
Date: 2007-10
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Persistent link: https://EconPapers.repec.org/RePEc:ham:qmwops:20711

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