Designing a Simple Loss Function for Central Banks

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...

Full description

Main Author: Debortoli, Davide
Other Authors: Kim, Jinill
Format: eBook
Language:English
Published: Washington, D.C. International Monetary Fund 2017, 2017
Series:IMF Working Papers
Subjects:
Online Access:
Collection: International Monetary Fund - Collection details see MPG.ReNa
LEADER 01948nmm a2200325 u 4500
001 EB001825657
003 EBX01000000000000000992103
005 00000000000000.0
007 cr|||||||||||||||||||||
008 180614 ||| eng
020 |a 1484309278 
020 |z 9781484309278 
020 |a 9781484309278 
100 1 |a Debortoli, Davide 
245 0 0 |a Designing a Simple Loss Function for Central Banks  |h electronic resource  |c Davide Debortoli 
260 |a Washington, D.C.  |b International Monetary Fund  |c 2017, 2017 
300 |a 56 p. 
653 |a Central Banks And Their Policies 
653 |a Central Banks Objectives 
653 |a All Countries 
653 |a Central Banks 
700 1 |a Kim, Jinill 
041 0 7 |a eng  |2 ISO 639-2 
989 |b IMF  |a International Monetary Fund 
490 0 |a IMF Working Papers 
028 5 0 |a 10.5089/9781484309278.001 
856 |u http://elibrary.imf.org/view/IMF001/24435-9781484309278/24435-9781484309278/24435-9781484309278.xml  |x Verlag  |3 Volltext 
082 0 |a 330 
520 |a 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