Robust Targeting Rules for Monetary Policy

Abstract

This paper explores robust optimal targeting rules in a standard forward looking model when i) policy maker has doubts about the parameters while private agents know the model and ii) policy maker and the private sector share the same doubts. It is shown that, while the robust optimal policy rule are the same in both cases, private sector's behavior, and hence the resulting equilibrium is different. Two distinct sources of parameter uncertainty are considered: When the agents' doubts take the form of uncertainty about the slope of the Phillips curve, robust policy rule prescribes a less aggressive response to deviations of inflation from the target - somewhat contrary to the recent findings in the literature. On the other hand, if the source of uncertainty is imperfect knowledge of persistence of shocks, robust monetary policy calls for a more aggressive response to inflation.

Keywords: Optimal Monetary Policy, Targeting Rules, Knightian Uncertainty, Robust Control

JEL Classification: E52, E58, D89