Monetary Policy Loss Functions: Two Cheers for the Quadratic
Preprint
Repository URI
Repository DOI
Change log
Authors
Abstract
The authors examine the implications for the optimal interest rate rule that follow from relaxing the assumption that the policy-maker's loss function is quadratic. They investigate deviations from quadratics for both symmetric and asymmetric preferences for a single target and find that (i) other characterisations of risk aversion than implied by the quadratic only affect dead-weight losses, unless there is multiplicative uncertainty; and (ii) asymmetries affect the optimal rule under both additive and multiplicative uncertainty but result in interest rate paths observationally similar, and in some cases equivalent, to those implied by a shifted quadratic. The results suggest that in the context of monetary policy-making the convenient assumption of quadratic losses may not be that drastic after all.