IDEAS home Printed from https://ideas.repec.org/p/anp/en2005/016.html
   My bibliography  Save this paper

A FEASIBLE AND OBJECTIVE CONCEPT OF OPTIMALITY: THE QUADRATIC LOSS FUNCTION AND U. S. MONETARY POLICY IN THE 1960's

Author

Listed:
  • Pedro Garcia Duarte

Abstract

The introduction of linear-quadratic methods in monetary economics in the 1960s tinged the intense debate about the optimal monetary policy instrument. These methods were widely used outside monetary economics because they delivered easy solutions to complex stochastic models. This same reason explains the success of quadratic loss functions according to the conventional wisdom among monetary economists. In this traditional narrative, Henri Theil and Herbert Simon are often cited by their proofs that models with quadratic objective functions have the certainty equivalence property. This attribute made the solution of these models feasible for the computers available at that time. This paper shows how the use of a quadratic loss function to characterize the behavior of central banks inaugurated an objective or uniform way of talking about optimality. In this respect, the discourse on optimal monetary policy stabilized. Moreover, a richer account of the quadratic approach to monetary policy debate emerges by analyzing how quadratic loss functions were used in operations research and management problems by groups of scientists that included economists like Modigliani and Simon. I argue that feasibility is only one important factor that explains the wide popularity of quadratic functions in monetary economics.

Suggested Citation

  • Pedro Garcia Duarte, 2005. "A FEASIBLE AND OBJECTIVE CONCEPT OF OPTIMALITY: THE QUADRATIC LOSS FUNCTION AND U. S. MONETARY POLICY IN THE 1960's," Anais do XXXIII Encontro Nacional de Economia [Proceedings of the 33rd Brazilian Economics Meeting] 016, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
  • Handle: RePEc:anp:en2005:016
    as

    Download full text from publisher

    File URL: http://www.anpec.org.br/encontro2005/artigos/A05A016.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Waud, Roger N, 1976. "Asymmetric Policymaker Utility Functions and Optimal Policy Under Uncertainty," Econometrica, Econometric Society, vol. 44(1), pages 53-66, January.
    2. Taylor, John B., 2001. "An Interview With Milton Friedman," Macroeconomic Dynamics, Cambridge University Press, vol. 5(1), pages 101-131, February.
    3. Friedman, Benjamin Morton, 1972. "Optimal Economic Stabilization Policy: An Extended Framework," Scholarly Articles 4554308, Harvard University Department of Economics.
    4. W. W. Cooper, 1955. "Presidential Address to TIMS," Management Science, INFORMS, vol. 1(2), pages 183-186, January.
    5. William A. Barnett, 2001. "A Conversation with Henri (Hans) Theil: His Experiences in the Netherlands during the Second World War," Econometrics 0111001, University Library of Munich, Germany.
    6. repec:cup:macdyn:v:5:y:2001:i:1:p:101-31 is not listed on IDEAS
    7. Friedman, Benjamin M, 1972. "Optimal Economic Stabilization Policy: An Extended Framework," Journal of Political Economy, University of Chicago Press, vol. 80(5), pages 1002-1022, Sept.-Oct.
    8. W. W. Cooper, 2002. "Abraham Charnes and W. W. Cooper (et al.): A Brief History of a Long Collaboration in Developing Industrial Uses of Linear Programming," Operations Research, INFORMS, vol. 50(1), pages 35-41, February.
    9. Chow, Gregory C, 1970. "Optimal Stochastic Control of Linear Economic Systems," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 2(3), pages 291-302, August.
    10. W. W. Cooper, 1951. "A Proposal for Extending the Theory of the Firm," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 65(1), pages 87-109.
    11. Colander, Conducted by David, 1999. "Conversations With James Tobin And Robert Shiller On The “Yale Tradition” In Macroeconomics," Macroeconomic Dynamics, Cambridge University Press, vol. 3(1), pages 116-143, March.
    12. Charles C. Holt & Franco Modigliani & Herbert A. Simon, 1955. "A Linear Decision Rule for Production and Employment Scheduling," Management Science, INFORMS, vol. 2(1), pages 1-30, October.
    13. Charles C. Holt & Franco Modigliani & John F. Muth, 1956. "Derivation of a Linear Decision Rule for Production and Employment," Management Science, INFORMS, vol. 2(2), pages 159-177, January.
    14. Poole, William, 1975. "The 1975 Report of the President's Council of Economic Advisers: Long on Analysis, Short on Policy," American Economic Review, American Economic Association, vol. 65(4), pages 539-547, September.
    15. Esther-Mirjam Sent, 2002. "How (Not) to Influence People: The Contrary Tale of John F. Muth," History of Political Economy, Duke University Press, vol. 34(2), pages 291-320, Summer.
    16. L. Wheaton Smith, Jr., 1956. "Current Status of the Industrial Use of Linear Programming," Management Science, INFORMS, vol. 2(2), pages 156-158, January.
    17. Sargent, Thomas J & Wallace, Neil, 1973. "Rational Expectations and the Dynamics of Hyperinflation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 14(2), pages 328-350, June.
    18. Esther-Mirjam Sent, 2005. "Simplifying Herbert Simon," History of Political Economy, Duke University Press, vol. 37(2), pages 227-232, Summer.
    19. Merrill M. Flood, 1956. "The Objectives of TIMS," Management Science, INFORMS, vol. 2(2), pages 178-184, January.
    20. Mirowski,Philip, 2002. "Machine Dreams," Cambridge Books, Cambridge University Press, number 9780521772839, January.
    21. Thomas J. Sargent, 1971. "The Optimum Monetary Instrument Variable in a Linear Economic Model," Canadian Journal of Economics, Canadian Economics Association, vol. 4(1), pages 50-60, February.
    22. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    23. E. C. Hope, 1953. "Discussion," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 2(1), pages 86-88, March.
    24. Anonymous, 1965. "Economic and Social Council," International Organization, Cambridge University Press, vol. 19(4), pages 1001-1042, October.
    25. Earl of Halsbury, 1955. "From Plato to the Linear Program," Operations Research, INFORMS, vol. 3(3), pages 239-254, August.
    26. Kareken, John H, 1970. "The Optimum Monetary Instrument Variable: A Comment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 2(3), pages 385-390, August.
    27. Milton Friedman, 2001. "Friedman on Friedman," Rivista di storia economica, Società editrice il Mulino, issue 1, pages 127-132.
    28. Mirowski,Philip, 2002. "Machine Dreams," Cambridge Books, Cambridge University Press, number 9780521775267, January.
    29. Arthur M. Okun, 1972. "Fiscal-Monetary Activism: Some Analytical Issues," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 3(1), pages 123-172.
    30. Judy L. Klein, 2000. "Economics for a Client: The Case of Statistical Quality Control and Sequential Analysis," History of Political Economy, Duke University Press, vol. 32(5), pages 25-70, Supplemen.
    31. Anonymous, 1965. "Economic and Social Council," International Organization, Cambridge University Press, vol. 19(1), pages 97-107, January.
    32. Muench, Thomas & Wallace, Neil, 1974. "On Stabilization Policy: Goals and Models," American Economic Review, American Economic Association, vol. 64(2), pages 330-337, May.
    33. William Poole, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(2), pages 197-216.
    34. Holbrook, Robert S & Shapiro, Harold, 1970. "The Choice of Optimal Intermediate Economic Targets," American Economic Review, American Economic Association, vol. 60(2), pages 40-46, May.
    35. Anon, 2002. "The Economy of Influence," Environment and Planning A, , vol. 34(8), pages 1331-1332, August.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Jean-Bernard Chatelain & Kirsten Ralf, 2017. "Can We Identify the Fed's Preferences?," Working Papers halshs-01549908, HAL.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Harashima, Taiji, 2007. "Hyperinflation, disinflation, deflation, etc.: A unified and micro-founded explanation for inflation," MPRA Paper 3836, University Library of Munich, Germany.
    2. David Kendrick, 1976. "Applications of Control Theory to Macroeconomics," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 5, number 2, pages 171-190, National Bureau of Economic Research, Inc.
    3. Sylvie Rivot, 2015. "Rule-based frameworks in historical perspective: Keynes' and Friedman's monetary policies versus contemporary policy-rules," The European Journal of the History of Economic Thought, Taylor & Francis Journals, vol. 22(4), pages 601-633, August.
    4. repec:spo:wpmain:info:hdl:2441/5oi5d12qn3983q921gleelod94 is not listed on IDEAS
    5. Marion Fourcade & Rakesh Khurana, 2013. "From social control to financial economics," Post-Print hal-03473899, HAL.
    6. Harashima, Taiji, 2008. "A Microfounded Mechanism of Observed Substantial Inflation Persistence," MPRA Paper 10668, University Library of Munich, Germany.
    7. Deleau Michel & Malgrange Pierre, 1976. "Application des méthodes d'optimisation aux modèles macroéconomiques de politique économique (l')," CEPREMAP Working Papers (Couverture Orange) 7606, CEPREMAP.
    8. repec:hal:spmain:info:hdl:2441/5oi5d12qn3983q921gleelod94 is not listed on IDEAS
    9. Duo Qin, 2006. "VAR Modelling Approach and Cowles Commission Heritage," Working Papers 557, Queen Mary University of London, School of Economics and Finance.
    10. Taiji Harashima, 2005. "The Cause of the Great Inflation: Interactions between the Government and the Monetary Policymakers," Macroeconomics 0510026, University Library of Munich, Germany, revised 17 Nov 2005.
    11. Claus Dierksmeier, 2011. "The Freedom–Responsibility Nexus in Management Philosophy and Business Ethics," Journal of Business Ethics, Springer, vol. 101(2), pages 263-283, June.
    12. Loisel, Olivier, 2021. "The implementation of stabilization policy," Theoretical Economics, Econometric Society, vol. 16(2), May.
    13. Jean-Bernard Chatelain & Kirsten Ralf, 2020. "How macroeconomists lost control of stabilization policy: towards dark ages," The European Journal of the History of Economic Thought, Taylor & Francis Journals, vol. 27(6), pages 938-982, November.
    14. John Duffy & M. Utku Unver, 2003. "Asset Price Bubbles and Crashes with Near-Zero-Intelligence Traders: Towards an Understanding of Laboratory Findings," Computational Economics 0307001, University Library of Munich, Germany, revised 17 Mar 2004.
    15. Wallace J. Hopp & David Simchi-Levi, 2021. "Management Science : The Legacy of the Past and Challenge of the Future," Management Science, INFORMS, vol. 67(9), pages 5306-5316, September.
    16. Sandra Silva & Aurora Teixeira, 2009. "On the divergence of evolutionary research paths in the past 50 years: a comprehensive bibliometric account," Journal of Evolutionary Economics, Springer, vol. 19(5), pages 605-642, October.
    17. Poitras, Geoffrey, 2023. "Cobweb Theory, Market Stability, And Price Expectations," Journal of the History of Economic Thought, Cambridge University Press, vol. 45(1), pages 137-161, March.
    18. Chatelain, Jean-Bernard & Ralf, Kirsten, 2018. "Publish and Perish: Creative Destruction and Macroeconomic Theory," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, vol. 46(2), pages 65-101.
    19. H. Spencer Banzhaf & James Boyd, 2012. "The Architecture and Measurement of an Ecosystem Services Index," Sustainability, MDPI, vol. 4(4), pages 1-32, March.
    20. Akhabbar, Amanar & Lallement, Jerôme, 2011. "« Appliquer la théorie économique de l’équilibre général » : de Walras à Leontief [Applying general equilibrium theory: from Walras to Leontief]," MPRA Paper 30210, University Library of Munich, Germany.
    21. Lothian, James R., 2014. "Monetary policy and the twin crises," Journal of International Money and Finance, Elsevier, vol. 49(PB), pages 197-210.
    22. Ivan Boldyrev & Olessia Kirtchik, 2014. "General Equilibrium Theory behind the Iron Curtain: The Case of Victor Polterovich," History of Political Economy, Duke University Press, vol. 46(3), pages 435-461, Fall.

    More about this item

    JEL classification:

    • B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics
    • B23 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Econometrics; Quantitative and Mathematical Studies

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:anp:en2005:016. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Rodrigo Zadra Armond (email available below). General contact details of provider: https://edirc.repec.org/data/anpecea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.