Monetary Policy Loss Functions: Two Cheers for the Quadratic
Chadha, Jagjit S.
Cambridge Working Papers in Economics
Faculty of Economics
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Schellekens, P., & Chadha, J. S. (2004). Monetary Policy Loss Functions: Two Cheers for the Quadratic. https://doi.org/10.17863/CAM.5191
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.
Classification-JEL: E42, E52, E61, Loss functions, Uncertainty, Optimal monetary policy rules
This record's DOI: https://doi.org/10.17863/CAM.5191
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