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Resuscitating the ad hoc loss function for monetary policy analysis

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  • Juan Paez-Farrell

    ()
    (School of Business and Economics, Loughborough University, UK)

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, targeting rules.

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File URL: http://www.lboro.ac.uk/departments/sbe/RePEc/lbo/lbowps/JPF_WP2012_06.pdf
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Bibliographic Info

Paper provided by Department of Economics, Loughborough University in its series Discussion Paper Series with number 2012_06.

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Date of creation: Jun 2012
Date of revision: Jun 2012
Handle: RePEc:lbo:lbowps:2012_06

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Web page: http://www.lboro.ac.uk/departments/sbe/research/economics/index.html
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Keywords: Optimal monetary policy; targeting rules; loss function; robustness.;

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References

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  1. Juan Paez-Farrell, 2009. "Monetary policy rules in theory and in practice: evidence from the UK and the US," Applied Economics, Taylor & Francis Journals, vol. 41(16), pages 2037-2046.
  2. Ignazio Angeloni & Gunter Coenen & Frank Smets, 2003. "Persistence, The Transmission Mechanism And Robust Monetary Policy," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 527-549, November.
  3. Ireland, Peter N., 2003. "Comment on: Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 977-982, July.
  4. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  5. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series 2002-5, Board of Governors of the Federal Reserve System (U.S.).
  6. John C. Williams & Andrew T. Levin, 2003. "Robust Monetary Policy with Competing Reference Models," Computing in Economics and Finance 2003 291, Society for Computational Economics.
  7. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
  8. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
  9. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2010. "Welfare-maximizing monetary policy under parameter uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 129-143.
  10. Richard Dennis, 2001. "Optimal policy in rational-expectations models: new solution algorithms," Working Paper Series 2001-09, Federal Reserve Bank of San Francisco.
  11. 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.
  12. Dennis, Richard, 2010. "When is discretion superior to timeless perspective policymaking?," Journal of Monetary Economics, Elsevier, vol. 57(3), pages 266-277, April.
  13. 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.
  14. Miguel Casares, 2006. "A close look at model-dependent monetary policy design," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 451-470.
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Cited by:
  1. 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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