Robust Monetary Policy in a Currency Union
A great number of recent researches have found importance of country specific shocks for optimal monetary policy construction in the context of a currency union. This however was almost completely overlooked by the analysis of optimal monetary policy under model uncertainty. The main purpose of our work is to fill this gap. For a model of a two-country currency union with sticky prices we have derived robust monetary policy that works reasonably well even in the worst case of model perturbations. We find some anti-attenuation effect of uncertainty and show that the central bank’s optimal reaction to economic shocks becomes more aggressive with an increase in the extent of misspecification.