Monetary Policy and Model Uncertainty in a Small Open Economy

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

No 14, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: We study the effects of optimized monetary policy in a semi-structural, estimated small open economy in situations where the policymaker has either complete or less than complete confidence in the model being free from misspecification errors. We use the robust control techniques developed by Dennis, Leitemo and Söderström (2006). We find that irrespective of the level of confidence to the model, the central bank may reduce loss by more than 80% by making a policy commitment. It is the open-economy channels introduce trade-offs in which commitment enhances policy outcome. If the policymaker lacks confidence in the model specification, a robust policymaker mainly fears that the exchange rate and domestic inflation equations are misspecified. Consequently, the robust policy is designed primarily to counteract these types of potential misspecifications. Policy becomes more aggressive towards all shocks. Although the exchange rate equation provides great opportunities for worst-case distortions, the exchange rate channels also provide ample ways in which policy can counteract distortions to the model, especially under policy commitment. The exchange rate channels can hence be viewed as both a curse and a blessing to the policymaker.

Keywords: Policy robustness; monetary policy rules; model uncertainty (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 E61 (search for similar items in EconPapers)
Date: 2006-07-04
References: Add references at CitEc
Citations:

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

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:sce:scecfa:14

Access Statistics for this paper

More papers in Computing in Economics and Finance 2006 from Society for Computational Economics Contact information at EDIRC.
Bibliographic data for series maintained by Christopher F. Baum ().