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Designing Central Bank Loss Functions

Stephen Miller () and Huiping Yuan ()

No 908, Working Papers from University of Nevada, Las Vegas , Department of Economics

Abstract: Kydland and Prescott (1977) consider the issue of the time-inconsistency of optimal policy and its source. Our paper provides additional insight on this issue. They develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. In our solution, the government appoints a central bank or delegates to the central bank an objective function that differs from the social welfare function. The central bank’s welfare function causes the consistent policy implemented by the central bank to prove optimal for society. The optimal institutional design for the Kydland-Prescott sequential-decision one-period model requires the appointment or delegation to a completely conservative central banker.

Keywords: Consistent policy; Optimal policy; Consistent targets (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2009-03
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Forthcoming International Journal of Business and Economics

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