Local robustness analysis: Theory and application

This paper develops a general framework for conducting local robustness analysis. By local robustness, we refer to the calculation of control solutions that are optimal against the least favorable model among models close to an initial baseline. We provide Nash and Stackelberg equilibrium characterizations of the choice of control. We apply this abstract formulation to a class of discrete time control problems. This analysis is conducted using frequency domain methods and is shown to involve certain fundamental limits to the efficacy of controls in such environments. Finally, we discuss some implications of our results for monetary policy. (c) 2005 Elsevier B.V. All rights reserved.