Understanding Central Bank Loss Functions: Implied and Delegated Targets

57 Pages Posted: 15 Nov 2009

See all articles by Huiping Yuan

Huiping Yuan

Xiamen University

Stephen M. Miller

University of Nevada, Las Vegas - Department of Economics; University of Connecticut - Department of Economics

Date Written: November 13, 2009

Abstract

The paper studies the dynamic nature of optimal solutions under commitment in Barro-Gordon and new-Keynesian models and, finds two interesting parameters - the implied targets and the persistence parameter that governs the adjustment toward the implied targets. The implied targets generally differ from the social ones, but exhibit a trade-off between targets and equal the long-run equilibrium values of target variables. The implied targets prove consistent with the models and the social targets do not. Moreover, the implied targets emerge in the long run according to the persistence parameter. As such, the government delegates to the central bank short-term, state-contingent targets, which guide discretionary policy to evolve along optimal paths as these targets converge to their long-run implied targets. For the Barro-Gordon model with output persistence, the correct delegated targets eliminate the constant average and state-contingent inflation biases, and a weight-liberal central bank removes the stabilization bias. For the new-Keynesian models, delegated targets, combined with the appropriate weight-liberal or –conservative central bank, can eliminate all three biases. The delegated targets may reflect backward- or forward-looking behavior, depending on the model.

Keywords: Optimal Policy, Central Bank Loss Functions, Policy Rules

JEL Classification: E420, E520, E580

Suggested Citation

Yuan, Huiping and Miller, Stephen M., Understanding Central Bank Loss Functions: Implied and Delegated Targets (November 13, 2009). Available at SSRN: https://ssrn.com/abstract=1505784 or http://dx.doi.org/10.2139/ssrn.1505784

Huiping Yuan

Xiamen University ( email )

Xiamen, Fujian 361005
China

Stephen M. Miller (Contact Author)

University of Nevada, Las Vegas - Department of Economics ( email )

4505 S. Maryland Parkway
Box 456005
Las Vegas, NV 89154
United States
702-895-3776 (Phone)
702-895-1354 (Fax)

HOME PAGE: http://faculty.unlv.edu/smiller/

University of Connecticut - Department of Economics

365 Fairfield Way, U-1063
Storrs, CT 06269-1063
United States

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