Title: Monetary policy in a small open economy with a preference for robustness
Description: We use robust control techniques to study the effects of model uncertainty on  monetary policy in an estimated, sem--structural, small-open-economy model of the  U.K. Compared to the closed economy, the presence of an exchange rate channel for  monetary policy not only produces new trade-offs for monetary policy, but it also  introduces an additional source of specification errors. We find that exchange rate  shocks are an important contributor to volatility in the model, and that the exchange  rate equation is particularly vulnerable to model misspecification, along with the  equation for domestic inflation. However, when policy is set with discretion, the  cost of insuring against model misspecification appears reasonably small.
Subjects: Monetary policy, Econometric models
Places: Great Britain