Robust monetary policy in a small open economy

We study how a central bank in a small open economy should conduct mon-etary policy if it fears that its model is misspecified. Using a New Keynesian model of a small open economy, we solve analytically for the optimal robust policy rule and the equilibrium dynamics, and we separately analyze the con-sequences of central bank robustness against misspecification concerning the determination of inflation, output, and the exchange rate. We show that an increase in the preference for robustness may make the central bank respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification. We also demonstrate that the price of being robust to misspecification in the Phillips curve or the output equation comes in the form of higher output and exchange rate variability, whereas ro-bustness against misspecification in the exchange rate equation comes at the cost of higher inflation variability