Understanding Central Bank Loss Functions: Implied and Delegated Targets

Huiping Yuan () and Stephen Miller

No 2009-39, Working papers from University of Connecticut, Department of Economics

Abstract: The paper studies the dynamic nature of optimal solutions under commitment in Barro-Gordon and new-Keynesian models and, finds two interesting parameters -- the implied targets and the persistence parameter that governs the adjustment toward the implied targets. The implied targets generally differ from the social ones, but exhibit a trade-off between targets and equal the long-run equilibrium values of target variables. The implied targets prove consistent with the models and the social targets do not. Moreover, the implied targets emerge in the long run according to the persistence parameter. As such, the government delegates to the central bank short-term, state-contingent targets, which guide discretionary policy to evolve along optimal paths as these targets converge to their long-run implied targets. For the Barro-Gordon model with output persistence, the correct delegated targets eliminate the constant average and state-contingent inflation biases, and a weight-liberal central bank removes the stabilization bias. For the new-Keynesian models, delegated targets, combined with the appropriate weight-liberal or -conservative central bank, can eliminate all three biases. The delegated targets may reflect backward- or forward-looking behavior, depending on the model.

Keywords: Optimal Policy; Central Bank Loss Functions; Policy Rules (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2009-10
New Economics Papers: this item is included in nep-mac and nep-mon
Note: Professor Yuan gratefully acknowledges the financial support from the National Social Science Foundation of China, the China Scholarship Council, and the Wang Yanan Institute for Studies in Economics, Xiamen University.
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:uct:uconnp:2009-39

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