Robust Monetary Rules under Unstructured and Structured Model Uncertainty

54 Pages Posted: 14 May 2008

See all articles by Paul Levine

Paul Levine

School of Economics, University of Surrey

Joseph Pearlman

London Metropolitan University - Department of Economics, Finance and International Business (EFIB)

Date Written: May 1, 2008

Abstract

This paper compares two contrasting approaches to robust monetary policy design. The first developed by Hansen and Sargent (2003, 2007) assumes unstructured model uncertainty and uses a minimax robustness criterion to design monetary rules. This contrasts with an older literature that structures uncertainty by seeking rules that are robust across competing views of the economy. This paper carries out and compares robust design exercises using both approaches using a standard 'canonical New Keynesian model'. We pay particular attention to a number of issues: First, we distinguish three possible forms of the implied game between malign nature and the policymaker in the Hansen-Sargent procedure. Second, in both approaches, we examine the consequences for robust rules of the zero lower bound (ZLB) constraint on the nominal interest rate, the monetary instrument. Finally, again for both types of robustness exercise we explore the implications of policy design when the policymaker is obliged to use simple Taylor-type interest rate rules.

Keywords: robustness, structured and unstructured uncertainty, zero lower bound

JEL Classification: E52, E37, E58

Suggested Citation

Levine, Paul L. and Pearlman, Joseph G., Robust Monetary Rules under Unstructured and Structured Model Uncertainty (May 1, 2008). ECB Working Paper No. 899. Available at SSRN: https://ssrn.com/abstract=1126671

Paul L. Levine (Contact Author)

School of Economics, University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 259 380 Ext. 2773 (Phone)
+44 1483 259 548 (Fax)

Joseph G. Pearlman

London Metropolitan University - Department of Economics, Finance and International Business (EFIB) ( email )

Economics Subject Group, LMBS
London EC2M 6SQ, EC2M 6SQ
United Kingdom

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