https://macropaperwarehouse.com/authors/michael-t.-kiley/Michael T. KileyHugo -- gohugo.ioen-ushttps://macropaperwarehouse.com/papers/monetary-policy-employment-shortfalls-and-the-natural-rate-hypothesis/https://macropaperwarehouse.com/papers/monetary-policy-employment-shortfalls-and-the-natural-rate-hypothesis/<p>This paper examines optimal monetary policy under discretion when the loss function is asymmetric — placing greater weight on employment shortfalls than on equivalently sized employment strength. The model satisfies the natural rate hypothesis (NRH): monetary policy is neutral in the long run, so persistent accommodation of above-potential activity raises inflation expectations without permanently boosting employment. The central paradox the paper establishes is that an asymmetric shortfalls-oriented loss function, despite its stated goal of reducing shortfalls, exacerbates them: the mechanism runs through the NRH expectation-adjustment channel, which creates an inflationary bias structurally analogous to the Barro-Gordon result. Mandating a central bank objective that is more symmetric than the social loss function — a conservative-in-asymmetry design — lowers both the frequency of activity shortfalls and the inflationary bias. As a corollary, the analysis implies that monetary accommodation of labor market strength requires justifications beyond the asymmetric costs of shortfalls, such as permanent effects of strong labor markets on economic potential.</p>