Monetary Policy Transparency in a Framework with Model Uncertainty

This paper discusses the problem of monetary policy transparency in a simple static robust control framework. In this framework, we identify two sources of monetary policy uncertainty. First, we identify the uncertainty about the central bank’s inflation stabilization preferences, which affects the private sector’s inflation expectations and therefore the realized inflation and output. On the other hand, uncertainty means that central bank is unsure about its model, in the sense that there is a group of approximate models that it also consider as possibly true and its objective is to choose a rule that will work under a range of different model specifications. We find that robustness reveals the emergence of a precautionary behaviour of the central bank in the case of unstructured model uncertainty, reducing thus central bank’s willingness to choise a high degree of monetary policy transparency