hero working papers

Monetary Policy in a Small Open Economy with a Preference for Robustness

Number: 316
Year: 2006
Author(s): Richard Dennis, Kai Leitemo and Ulf Soderstrom
monetary policy in an estimated, semi-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.

Keywords: political equilibria, aging, postponing retirement
JEL codes: H53, H55, D72