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

Davide Debortoli, Jinill Kim, Jesper Lindé and Ricardo Nunes

No 2017/164, IMF Working Papers from International Monetary Fund

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: WP; central bank; Central banks’ objectives; simple loss function; monetary policy design; sticky prices and sticky wages; DSGE models; loss function; inflation-output gap mandate; wage inflation; output gap fluctuation; inflation-output gap trade-off; Output gap; Inflation; Wages; Production growth; Labor markets; Europe (search for similar items in EconPapers)
Pages: 56
Date: 2017-07-19
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=45064 (application/pdf)

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)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:2017/164

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().