We study an optimal robust monetary policy for a small open economy. The robust control approach assumes that economic agents cannot assign probabilities to a set of plausible models and rather focuses on the worst possible misspecification from a benchmark model. Our findings suggest that, first, conducting a global robust optimal monetary policy is limited as deviations from the benchmark model lead to multiple equilibria. Second, when the central bank considers uncertainty only in the IS Curve or in the UIP, the space of unique solutions is expanded. In fact, the central bank reacts more aggressively to demand and real exchange rate shocks when it is robust to misspecifications in the IS curve only. Finally, our results suggest that the global robust optimal monetary policy is limited due to inflation persistency and the low exchange rate pass-through. The importance of anchoring inflation expectations is highlighted.

This paper studies how a central bank's preference for robustness against model misspecification affects the design of monetary policy in a New-Keynesian model of a small open economy. Due to the simple model structure, we are able to solve analytically for the optimal robust policy rule, and we separately analyze the effects of robustness against misspecification concerning the determination of inflation, output and the exchange rate. We show that an increased central bank preference for robustness makes monetary policy respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification.

This paper studies optimal monetary policy in a two-sector small open economy model under segmented asset markets and sticky prices. We solve the Ramsey problem under full commitment, and characterize the optimal monetary policy in a calibrated version of the model. The findings of the paper are threefold. First, the Ramsey solution mimics the allocations under flexible prices. Second, under the optimal policy the volatility of non-tradable inflation is close to zero. Third, stabilizing nontradable inflation is optimal regardless of the financial structure of the small open economy. Even for a moderate degree of price stickiness, implementing a monetary policy that mitigates asset market segmentation is highly distortionary. This last result suggests that policymakers should resort to other policy instruments in order to correct financial imperfections.

Introducing habit formation into an open economy macroeconomic model with price stickiness, we examine the characteristics of an optimal monetary policy. We find that, first, the optimal policy rule entails interest rate smoothing and responds to the lagged values of the foreign interest rate and domestic technology shocks as well as their current values. Second, habit formation enriches the dynamics of the economy with a persistent, hump-shaped response of consumption to shocks. Finally, when habit formation does matter, the optimal policy rule achieves a greater welfare improvement over alternative policy rules by achieving lower macroeconomic variability.

This paper studies how a central bank's preference for robustness against model misspecification affects the design of monetary policy in a New-Keynesian model of a small open economy. Due to the simple model structure, we are able to solve analytically for the optimal robust policy rule, and we separately analyze the effects of robustness against misspecification concerning the determination of inflation, output and the exchange rate. We show that an increased central bank preference for robustness makes monetary policy respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification.