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You Might as Well be Hung for a Sheep as a Lamb: The Loss Function of an Agent

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  • Charles Goodhart
  • Margaret Bray

Abstract

Most of those who take macro and monetary policy decisions are agents. The worst penalty which can be applied to these agents is to sack them. Agents thus have loss functions which are bounded above. We work with a bell loss function which has this property. With additive uncertainty the certainty equivalence which holds for a quadratic loss function breaks down with a bell loss function when there are two or more targets. With multiplicative (Brainard) uncertainty policy is more conservative than in the absence of multiplicative uncertainty, but less so with the bell than the quadratic loss function.

Suggested Citation

  • Charles Goodhart & Margaret Bray, 2002. "You Might as Well be Hung for a Sheep as a Lamb: The Loss Function of an Agent," FMG Discussion Papers dp418, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp418
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/DP418.pdf
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    Cited by:

    1. Lars E.O. Svensson, 2003. "Optimal Policy with Low-Probability Extreme Events," NBER Working Papers 10196, National Bureau of Economic Research, Inc.
    2. Alberto Locarno, 2007. "Imperfect Knowledge, Adaptive Learning, and the Bias Against Activist Monetary Policies," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 47-85, September.
    3. Stracca, Livio, 2004. "Behavioral finance and asset prices: Where do we stand?," Journal of Economic Psychology, Elsevier, vol. 25(3), pages 373-405, June.
    4. Fielding, David & Stracca, Livio, 2007. "Myopic loss aversion, disappointment aversion, and the equity premium puzzle," Journal of Economic Behavior & Organization, Elsevier, vol. 64(2), pages 250-268, October.

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