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A1754
Title: Robust vs risk-sensitive monetary policy in a linear model of the Polish economy Authors:  Mariusz Gorajski - University of Lodz (Poland) [presenting]
Abstract: For the majority of central banks the short-term rate paths are smooth and only gradual changes can be observed. Optimal monetary policy models in the linear-quadratic framework produce high variability of interest rates, and are hence inconsistent with the data. One can obtain gradual behaviour of optimal monetary policy by adding an interest rate smoothing term to the central bank objective. This heuristic procedure has not much substantiation in the central banks targets and raises the question: What are the rational reasons for the gradual movements in the monetary policy instrument? First, we determine optimal monetary policies in a VAR model of the Polish economy with parameter uncertainty. We show that there exists a structure of the multiplicative uncertainty in the optimal linear-quadratic model that explains the central banks behaviour. Thus proving that parameter uncertainty can be the rationale for timid movements in the short-interest rate dynamics. Finally, we show that there is trade of between parameter uncertainty and the interest rate smoothing incentive. Second, we derive the risk-sensitive strategies of the central banks characterized by a different level of sensitivity to the risk of not achieving the objectives. We observe a positive influence of the risk parameter on the strength of optimal policy response to exogenous shock.