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|How does monetary policy affect welfare?||575.37 KB|
The present paper addresses the question of how to estimate a social welfare function defined over inflation and unemployment that can help inform the policy decisions of central banks by providing a way to measure the well-being costs arising from macroeconomic fluctuations. Consider the case of a central bank seeking to achieve price stability in an economy which currently has a high inflation rate. It faces a decision regarding how much to increase interest rates.
The more it increases rates, the more unemployment may be pushed up and the quicker inflation may be reduced, at least in the short-run, according to the Phillip’s curve trade-off. Consequently, it is desirable to try to derive the welfare losses that stem from changes in unemployment compared to inflation. One way to do so is by obtaining direct measurements of individual subjective well-being from survey questions. These data can subsequently be correlated with unemployment and inflation rates in order to estimate the relative costs of these variables.
The sample for this study includes one million people in 138 nations over 12 years. Unemployment and inflation reduce well-being, although the ratio of the size of the effect varies dramatically between 2 and 4.6, depending upon which dimension of well-being is chosen.