Cover IMF Working Papers
Buy Book in Print
Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense?
Author:
Davide Debortoli null

Search for other papers by Davide Debortoli in
Current site
Google Scholar Close
,
Mr. Jinill Kim null

Search for other papers by Mr. Jinill Kim in
Current site
Google Scholar Close
,
Jesper Lindé null

Search for other papers by Jesper Lindé in
Current site
Google Scholar Close
, and
Mr. Ricardo C Nunes
Search for other papers by Mr. Ricardo C Nunes in
Current site
Google Scholar Close
Series:
IMF Working Papers
Volume/Issue:
Volume 2017: Issue 164
Language:
English
Publication Date:
19 Jul 2017
DOI:
https://doi.org/10.5089/9781484309278.001
ISBN:
9781484309278
ISSN:
1018-5941
Pages:
56
Keywords:
WP; central bank; Central banks’ objectives; simple loss function; monetary policy design; sticky prices and sticky wages; DSGE models; loss function; inflation-output gap mandate; wage inflation; output gap fluctuation; inflation-output gap trade-off; Output gap; Inflation; Wages; Production growth; Labor markets; Europe
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Download PDF (1.5 MB) Download Epub
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.
  • Collapse
  • Expand
Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund