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

Speaker:Jinill Kim, Professor, Department of Economics, Korea University

Date: October 24 (Wednesday)

Time: 10:00-11:30am

Location: Building 4 Room 101

Language: English

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.

About the speaker:

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.