Monetary Policy with Parameter Uncertainty in Small-Open Economy
Recent research in model uncertainty has mainly focused on models of closed economy. In a relevant paper, Giannoni (2002) nds that when the policymaker is uncertain about the numerical value of the structural parameters of the economy, he will optimally respond more aggressively to ination and output gap uctuations. That nding contradicts what found in a pioneering paper by Brainard (1967). The aim of this paper is to extend the analysis of uncertainty implications to a new keynesian small open economy model. In a minmax approach, the central bank derives an optimal policy plan by implementing a Taylor rule. It is shown that if there is uncertainty about the degree of price stickiness and the elasticity of substitution between domestic and foreign goods it is optimal to set interest rates in a less aggressive way. Even if we shut o the foreign channel, by slightly modifying the model, the Brainard principle holds. These results are found for reasonable and experienced degrees of uncertainty in the price stickiness and the elasticity of substitution between domestic and foreign goods.