Inflation persistence and robust monetary policy design

This paper examines the performance of optimised interest-rate rules when there is uncertainty about a key determinant of the monetary transmission mechanism, namely the degree of persistence characterising the inflation process. The paper focuses on the euro area and utilises two variants of an estimated small-scale macroeconomic model featuring distinct types of staggered contracts specifications which induce quite different degrees of inflation persistence. The paper shows that a cautious monetary policy-maker is well-advised to design and implement interest-rate policies under the assumption that inflation persistence is high when there is considerable uncertainty about the prevailing degree of inflation persistence. Such policies are characterised by a relatively aggressive response to inflation developments and exhibit a substantial degree of inertia.