On the welfare costs of misspecified monetary policy objectives |
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Authors: | Sanvi Avouyi-Dovi Jean-Guillaume Sahuc |
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Affiliation: | a Banque de France, 31 rue Croix des Petits Champs, 75049 Paris, France and University of Paris-Dauphine;b EDHEC Business School, 24 avenue Gustave Delory, 59057 Roubaix, France |
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Abstract: | This paper quantifies the effects on welfare of misspecified monetary policy objectives in a stylized DSGE model. We show that using inappropriate objectives generates relatively large welfare costs. When expressed in terms of ‘consumption equivalent’ units, these costs correspond to permanent decreases in steady-state consumption of up to two percent. The latter are generated by both the inappropriate choice of weights and the omission of variables. In particular, it is costly to assume an interest-rate smoothing incentive for central bankers when it is not socially optimal to do so. Finally, a parameter uncertainty decomposition indicates that uncertainty about the properties of markup shocks gives rise to the largest welfare costs. |
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Keywords: | Welfare Monetary policy objectives DSGE model Bayesian econometrics |
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