Designing a Simple Loss Function for the Fed: Does the Dual Mandate Make Sense?

Jesper Lindé, Jinill Kim, Ricardo Nunes and Davide Debortoli

No 10409, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Yes, it makes a lot of sense. Using the Smets and Wouters (2007) model of the U.S. economy, we find that the role of the output gap should be equal to or even more important than that of inflation when designing a simple loss function to represent household welfare. Moreover, we document that a loss function with nominal wage inflation and the hours gap provides an even better approximation of the true welfare function than a standard objective based on inflation and the output gap. Our results hold up when we introduce interest rate smoothing in the simple mandate to capture the observed gradualism in policy behavior and to ensure that the probability of the federal funds rate hitting the zero lower bound is negligible.

Keywords: Central banks' objectives; Household welfare; Linear-quadratic approximation; Monetary policy design; Simple loss function; Smets-wouters model (search for similar items in EconPapers)
JEL-codes: C32 E58 E61 (search for similar items in EconPapers)
Date: 2015-02
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:
Working Paper: Designing a Simple Loss Function for the Fed: Does the Dual Mandate Make Sense? (2016)
Working Paper: Designing a simple loss function for the Fed: does the dual mandate make sense? (2015)
Working Paper: Designing a Simple Loss Function for the Fed: Does the Dual Mandate Make Sense? (2014)
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