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Resuscitating the ad hoc loss function for monetary policy analysis

  • Juan Paez-Farrell

    ()

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

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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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
Contact details of provider: Postal: Loughborough, Leicestershire, LE11 3TU
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Web page: http://www.lboro.ac.uk/departments/sbe/research/economics/index.html

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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.
  2. Christian Jensen & Bennett C. McCallum, 2002. "The Non-Optimality of Proposed Monetary Policy Rules Under Timeless-Perspective Commitment," NBER Working Papers 8882, National Bureau of Economic Research, Inc.
  3. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
  4. 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.
  5. 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.
  6. 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.
  7. Levin, Andrew T. & Williams, John C., 2003. "Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 945-975, July.
  8. Richard Dennis, 2001. "Optimal policy in rational-expectations models: new solution algorithms," Working Paper Series 2001-09, Federal Reserve Bank of San Francisco.
  9. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  10. Páez-Farrell, Juan, 2007. "Monetary Policy Rules in Theory and in Practice: Evidence from the UK and the US," Cardiff Economics Working Papers E2007/13, Cardiff University, Cardiff Business School, Economics Section.
  11. Miguel Casares, 2006. "A close look at model-dependent monetary policy design," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 451-470.
  12. 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.
  13. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  14. Dennis, Richard, 2010. "When is discretion superior to timeless perspective policymaking?," Journal of Monetary Economics, Elsevier, vol. 57(3), pages 266-277, April.
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