This paper studies robust policy when the policymaker has Knightian uncertainty about the exact position of the effective lower bound (ELB). First, we characterize optimal discretionary policy when a benevolent policymaker controls the nominal interest rate and the level of government spending. Compared to the full information case, an uncertainty-averse policymaker overestimates the level of the ELB, thereby triggering a more aggressive reduction in the nominal interest rate prior to the liquidity trap. Furthermore, the anticipation of a larger increase in public spending improves the trade-off between inflation and the output gap, and dampens the perceived worst-case level of the ELB. As a result, a less conservative fiscal stabilization is desirable to address the uncertainty concerns of the policymaker by partially substituting for the nominal interest rate at the ELB. Moreover, an inflation-conservative policymaker mitigates the impact of uncertainty on equilibrium outcomes even better than a fiscally active policymaker.

The last decades proved that policymaking without considering uncertainty is impracticable. In an environment of uncertainty, policymakers have doubts about the policy models they routinely use. This paper focuses specifically on the situation where uncertainty on the financial side of the economy leads to misspecification in the policy model. We describe a coherent strategy for policymakers who are averse to model misspecification and analyze optimal policy design in the face of Knightian uncertainty. To do so, we augment a financial DSGE model with model misspecification in a simple minimax framework where the central bank plays a zero-sum game versus a hypothetical evil agent. The policy is tailored to insure against the worst-case outcomes. We show that model ambiguity on the financial side requires a passive monetary policy stance. However, if the uncertainty originates from the supply side of the economy, an aggressive response of interest rate is required. We also show the impact of an additional macroprudential tool on the dynamics of the economy.

The policy debate in Turkey over the impact of interest rate on inflation concerns the question of what policymakers should do when faced with volatile and high inflation. Motivated by this discussion, we provide an empirical analysis by connecting the cost channel to the Phillips relation. Our findings prove the existence of the cost channel. However, other determinants of inflation -labor share of income, prices of imported inputs and consumption goods- dominate the cost channel in Turkey.

Macroprudential policies have become essential tools for policymakers to maintain financial stability. We investigate the impact of macroprudential policies on the current account balance, considering the link between external imbalances and financial stability. Building on a panel VAR model, we further document that usage of a macroprudential instrument is associated with an improvement in the current account balance. Our findings suggest that the positive impact of macroprudential policy measures on the current account balance is more substantial in the deficit countries.

COVID-19 has led to changes in individuals' consumption habits, which will cause the calculation of inflation based on the average consumption basket to give distorted information. Using debit and credit card spending data of Turkey, we build CPI weights and compute an alternative pandemic consumption basket price index for Jan 2020-Feb 2021. Our findings show that the pandemic inflation is higher than the official inflation rate during the first lockdown, suggesting a behavioral change in consumption. However, in the reopening period, old habits come back. During the second lockdown, the difference between the pandemic and the official inflation rates is trivial in comparison with the first lockdown.

This paper analyzes whether and how model uncertainty affects the amplification mechanism of the New Keynesian models in a simple min-max framework where the central bank plays a zero-sum game versus a hypothetical, evil agent. A first finding on a benchmark model with staggered price setting is that a robust optimal commitment policy necessitates more aggressive policy under a demand shock. Further, bringing additional persistence into the model deteriorates the effectiveness of monetary policy. Hence, allowing for either habit formation or partial indexation of prices to lagged inflation rate requires a stronger response for the policy to a demand shock. Together with the specification doubts, in order to reassure the private sector and signal that it will stabilize the fluctuations in the output gap, the policymaker reacts more aggressively as persistence rises. Although inflation persistence does not change the impact of model uncertainty, habit formation in consumption eliminates even reverses the impact of uncertainty on the policy reaction to a supply shock. In all cases, policymaker attributes less importance to nominal interest rate inertia with concerns about model uncertainty.

This paper studies how asset price model misspecification affects the conduct of monetary policy under commitment in a New Keynesian model using robust control techniques. We find that monetary policy reacts aggressively to both asset price and inflation shocks to guard herself against worst-case outcome.

Little is known about the impact of monetary policy on asset prices in emerging markets. This study applies the heteroscedasticity-based GMM for financial markets in Turkey. The results suggest that event study estimates are biased for some asset returns.

This paper provides an extensive analysis of card spending during the COVID-19 pandemic in Turkey by using weekly aggregated and sectoral credit and debit card spending data from March 2014 to December 2020. At an aggregated level, we show that aggregate demand decreases significantly at the early stages of COVID-19 and seems to reinstate its pre-COVID trend. However, when we include the pre-existing conditions of Turkey, the 2018 currency crisis, we observe that the recovery in demand is not that strong. To highlight the underlying reasons for structural change in aggregate demand, we estimate the model with stringency index and unemployment-related search index. The estimated model indicates that containment measures and restrictions and fear of job/income loss mainly explain the overall impact of COVID-19 on aggregate demand. We also examined sectoral data to understand aggregate demand dynamics better. Only the stable and delayable sectors have reached a trend above their pre-pandemic trajectories. However, the social and work-related sectors are far from their respective pre-pandemic trend.

The interaction between monetary and fiscal policy is particularly relevant in the presence of an effective lower bound (ELB) constraining nominal interest rates. We characterize optimal discretionary policy when a benevolent policymaker controls the short-term nominal interest rate and the level of government spending. Then we study how Knightian uncertainty about the ELB affects the interaction between monetary and fiscal policy. We find that it is optimal to increase public expenditure only in a liquidity trap and that an uncertainty-averse policymaker overestimates the ELB, thereby triggering a more aggressive reduction in the nominal interest rate prior to the liquidity trap. However, the anticipation of a more active fiscal policy at the worst-case location of the ELB mitigates the impact of uncertainty on the policy rate. Moreover, we examine different policy regimes, showing that forward guidance turns out to be more effective than fiscal policy in responding to the crisis, also in the case in which it is coupled with a countercyclical fiscal policy rule. Fiscal policy remains as a buffer against ELB uncertainty.

I study how the optimal behaviour of a central bank changes if the central bank has a concern for robustness regarding model uncertainty when there is a possibility of a regime switch in the economy in which transmission mechanism of the monetary policy weakens. The aim is to stress the expectational effects arising from the regime-switching structure. The framework allows identifying the contribution of time-varying doubts about model misspesification on top of the risk of a future weakening of the policy transmission. The results imply a more active policy stance to reduce the possibility to experience a deterioration of monetary transmission mechanism even in normal times.