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

Debortoli, D, Kim, J, Lindé, J and Nunes, Ricardo (2018) Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense? Economic Journal.

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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, stabilising economic activity also stabilises 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-o¤ between stabilising inflation and resource utilisation, and also when imposing a moderate degree of interest rate volatility.

Item Type: Article
Divisions : Faculty of Arts and Social Sciences > School of Economics
Authors :
NameEmailORCID
Debortoli, D
Kim, J
Lindé, J
Nunes, Ricardoricardo.nunes@surrey.ac.uk
Date : 26 July 2018
DOI : 10.1111/ecoj.12630
Copyright Disclaimer : This is the peer reviewed version of the following article: Debortoli, D, Kim, J, Lindé, J and Nunes, Ricardo (2018) Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense? Economic Journal, DOI:10.1111/ecoj.12630, which has been published in final form at https://onlinelibrary.wiley.com/doi/pdf/10.1111/ecoj.12630. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions.
Depositing User : Melanie Hughes
Date Deposited : 18 Jul 2018 08:42
Last Modified : 08 Nov 2018 09:50
URI: http://epubs.surrey.ac.uk/id/eprint/848728

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