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BCAM 1701
Ekaterina Pirozhkova
Financial frictions and robust monetary policy in the models of New Keynesian framework

In this paper I study how financial frictions affect robustness of monetary policy in DSGE models in the case of model uncertainty. The types of frictions I consider are financial accelerator and collateral constraints. Modeling monetary policy in terms of optimal interest rate rules, I find that welfare-maximizing policies for the models with financial frictions are robust to model uncertainty. Policy rule optimal for the basic New Keynesian model is not robust. Thereby I show that when there is uncertainty about what type of frictions is at work, a policymaker exposes economy to risks of significant welfare losses by using a reference model without frictions as economy representation. Using fault tolerance approach I find that modified policy rule optimal for the basic New Keynesian model is robust when it allows to respond to fluctuations in output.

Keywords: optimal monetary policy rules, financial frictions, DSGE models, robustness.

JEL Classification: E32, E37, E44, E52.

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