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Resuscitating the ad hoc loss function for monetary policy analysis

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  • Paez-Farrell, Juan

Abstract

Working with micro-founded loss functions to derive and analyse optimal policy ensures consistency with the model used and overcomes the misleading prescriptions that result from using exogenous ad hoc loss functions. However, when allowance is made for the fact that different theories of inflation persistence can result in the same, observationally equivalent, hybrid New Keynesian Phillips curve such conclusions may no longer hold. Each theory implies its own loss function and will therefore result in different policy prescriptions. In this paper I analyse the welfare consequences of using ad hoc loss functions versus the micro-founded, but potentially incorrect, policy objectives.

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Bibliographic Info

Article provided by Elsevier in its journal Economics Letters.

Volume (Year): 123 (2014)
Issue (Month): 3 ()
Pages: 313-317

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Handle: RePEc:eee:ecolet:v:123:y:2014:i:3:p:313-317

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Web page: http://www.elsevier.com/locate/ecolet

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Keywords: Optimal monetary policy; Commitment; Loss function; Robustness;

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References

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  1. Thomas Laubach & John C. Williams & Rochelle M. Edge, 2007. "Welfare-Maximizing Monetary Policy under Parameter Uncertainty," 2007 Meeting Papers 311, Society for Economic Dynamics.
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  9. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
  10. Walsh, Carl E., 2005. "Endogenous objectives and the evaluation of targeting rules for monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 889-911, July.
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  12. Jensen, Christian & McCallum, Bennett T., 2002. "The non-optimality of proposed monetary policy rules under timeless perspective commitment," Economics Letters, Elsevier, vol. 77(2), pages 163-168, October.
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Cited by:
  1. Kienzler, Daniel & Schmid, Kai D., . "Hysteresis in Potential Output and Monetary Policy," Working Papers on Finance 1328, University of St. Gallen, School of Finance.
  2. Kienzler, Daniel & Schmid, Kai Daniel, 2013. "Monetary policy and hysteresis in potential output," University of Tuebingen Working Papers in Economics and Finance 55, University of Tuebingen, Faculty of Economics and Social Sciences.

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