No. 1339 - Optimal robust monetary policy with parameters and output gap uncertainty

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by Adriana Grasso and Guido TraficanteJune 2021

The work characterizes optimal and robust monetary policy to the joint presence of two sources of uncertainty, stemming from the imperfect measurement (i) of macroeconomic variables and (ii) of the structural parameters of the model. The optimal policy is compared with what would occur with full knowledge of both the variables and the parameters of the model, or only of the former. Previous papers have only considered the role of the two sources of uncertainty separately.

The results indicate that, in the event of 'double uncertainty', a central bank that aims to minimize fluctuations in the output gap, inflation and the interest rate should react to shocks on the natural interest rate more aggressively than in both the case of having full information, and of uncertainty over the parameters of the model alone, in contrast to the 'Brainard principle', which suggests a more cautious response.

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