Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense?

Jinill Kim, Jesper Lindé, Ricardo Nunes and Davide Debortoli
Authors registered in the RePEc Author Service: Jesper Lindé

No 958, Working Papers from Barcelona School of Economics

Abstract: Yes, it makes a lot of sense. This paper studies how to design simple loss functions for central banks, as parsimonious approximations to social welfare. We show, both analytically and quantitatively, that simple loss functions should feature a high weight on measures of economic activity, sometimes even larger than the weight on inflation. Two main factors drive our result. First, stabilizing economic activity also stabilizes other welfare relevant variables. Second, the estimated model features mitigated inflation distortions due to a low elasticity of substitution between monopolistic goods and a low interest rate sensitivity of demand. The result holds up in the presence of measurement errors, with large shocks that generate a trade-off between stabilizing inflation and resource utilization, and also when ensuring a low probability of hitting the zero lower bound on interest rates.

Keywords: DSGE models; Central banks’ objectives; simple loss function; monetary policy design; sticky prices and sticky wages (search for similar items in EconPapers)
JEL-codes: C32 E58 E61 (search for similar items in EconPapers)
Date: 2017-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense? (2019)
Working Paper: Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense? (2019)
Working Paper: Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense? (2017)
Working Paper: Designing a simple loss function for central banks: Does a dual mandate make sense? (2017)
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