A Positive Theory of Monetary Policy and Robust Control

Bank of Finland Discussion Paper No. 18/2003

29 Pages Posted: 29 Oct 2003

Date Written: August 12, 2003

Abstract

This paper applies the robust control approach to a simple positive theory of monetary policy, when the central bank's model of the economy is subject to misspecifications. It is shown that a central bank should react more aggressively to supply shocks when the model misspecifications grow larger. Moreover, the model misspecifications aggravate the inflation bias and a trade-off between output stabilisation and inflation worsens when the uncertainty surrounding the central bank's model increases. This implies that the larger the model misspecifications are, the more inflation-averse the central bank should be.

Keywords: Risk-sensitivity, robust control theory, monetary policy, Brainard conservatism, model uncertainty

JEL Classification: E58

Suggested Citation

Kilponen, Juha, A Positive Theory of Monetary Policy and Robust Control (August 12, 2003). Bank of Finland Discussion Paper No. 18/2003. Available at SSRN: https://ssrn.com/abstract=438122 or http://dx.doi.org/10.2139/ssrn.438122

Juha Kilponen (Contact Author)

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2847 (Phone)
+358 10 831 2294 (Fax)

HOME PAGE: http://www.bof.fi/en/suomen_pankki/organisaatio/asiantuntijoita/kilponen_juha/

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