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Model Uncertainty and Delegation: A Case for Friedman's k-Percent Money Growth Rule?

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  • Views expressed are those of the authors and do not necessarily reflect those of Bank of Finland. This paper was written while Leitemo was visiting the Bank of Finland as a visiting scholar. The Bank of Finland's hospitality is greatly appreciated. We are grateful to Tuomas Takalo and Jouko Vilmunen for comments to an earlier draft of this paper.

Abstract

Model uncertainty affects the monetary policy delegation problem. If there is uncertainty with regards to the determination of the delegated objective variables, the central bank will want robustness against potential model misspecifications. We show that with plausible degree of model uncertainty, delegation of the Friedman rule of increasing the money stock by k percent to the central bank will outperform commitment to the social loss function (flexible inflation targeting). The reason is that the price paid for robustness under flexible inflation targeting outweighs the inefficiency of money growth targeting. Imperfect control of money growth does not change this conclusion.

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