Scandinavian Working Papers in Economics
Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)
No 366: Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense?
Davide Debortoli (), Jinill Kim (), Jesper Lindé () and Ricardo Nunes ()
Additional contact information
Davide Debortoli: UPF, CREI and Barcelona GSE
Jinill Kim: Korea University
Jesper Lindé: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Ricardo Nunes: University of Surrey and CIMS
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 imposing a moderate degree of interest rate volatility.
Keywords: Central banksobjectives; simple loss function; monetary policy design; sticky prices and sticky wages; DSGE models
66 pages, First version: July 1, 2018. Revised: March 1, 2019.
Full text files
no.-366-designing-a-...ndate-make-sense.pdfFull text
Questions (including download problems) about the papers in this series should be directed to Lena Löfgren ()
Report other problems with accessing this service to Sune Karlsson ().
This page generated on 2024-02-05 17:13:28.