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Utility functions for central bankers: the not so drastic quadratic

  • Chadha, J.S.
  • Schellekens, P.

Following Blinder's (1997) suggestion, we examine the implications for the optimal interest rate rule following the relaxation of the assumption that the policymaker's loss function is quadratic. We investigate deviations from quadratics for both symmetric and asymmetric preferences for a single target and find that: (i) other characterisations of risk aversion, than that implied by the quadratic, only affect dead-weight losses, unless there is also muliplicative uncertainty; (ii) asymmetries affect the optimal rule under both additive and muliplicative uncertainty but result in interest rate paths observationally similar, and in some cases equivalent, those implied by a shifted quadratic; (iii) the use of an asymmetric los functions leads to important insights on the issues of goal independence and monetary policy delegation; (iv) non-quadratic preferences, per se , are neither sufficient nor necessary to generate the 'Brainard conservatism principle' and thus do not offer much added value when analysing the policy issues of caution and gradualism. Our results suggest that in the context of monetary policymaking the convenient assumption of quadratic losses may not be that drastic after all.

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Paper provided by Economics Division, School of Social Sciences, University of Southampton in its series Discussion Paper Series In Economics And Econometrics with number 9818.

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Date of creation: 01 Jan 1998
Date of revision:
Handle: RePEc:stn:sotoec:9818
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