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

Ricardo Nunes, Jinill Kim, Jesper Lindé and Davide Debortoli

No 1043, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: Yes. Using the workhorse 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 represenst 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 objective 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.

Date: 2014
New Economics Papers: this item is included in nep-dge and nep-mac
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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? (2015)
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