How Does Monetary Policy Affect Welfare? Some New Estimates Using Data on Life Evaluation and Emotional Well‐Being

• Published date: 01 December 2023
• Author: LINA EL‐JAHEL,ROBERT MACCULLOCH,HAMED SHAFIEE
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/jmcb.13000

DOI: 10.1111/jmcb.13000

LINA EL-JAHEL

ROBERT MACCULLOCH

HAMED SHAFIEE

How Does Monetary Policy Affect Welfare? Some

New Estimates Using Data on Life Evaluation and

Emotional Well-Being

Models on the optimal design of monetary policy typically rely on a wel-

fare loss function dened over unemployment and ination. We estimate

such a function using two different dimensions of well-being. The rst eval-

uates how close one is to “the best possible life” on a ladder scale. The

second captures the emotional quality of everyday experiences. Our Gallup

World Poll sample covers 1.5 million people in 141 nations from 2005 to

2019. Unemployment and ination reduce well-being across all measures.

The ratio of the unemployment-to-ination effect is 6.2 for the “Ladder-

of-Life.” It is lower for positive day-to-day experiences and higher for

negative ones.

JEL codes:E24, E31, E52, I31

MANY COUNTRIES HAVE ENACTED LEGISLATION

that ties the ultimate purpose of their Central Banks to promoting welfare or well-

being (see Mishkin 2007). For example, in the case of Australia:

… it is the duty of the Reserve Bank Board … to ensure that the monetary and banking

policy of the Bank is directed to … the economic prosperity and welfare of the people

of Australia. (Section 10(2), Reserve Bank of Australia Act 1959)

L E-J is an Associate Professor of Finance at the University of Auckland Business School

(E-mail: l.eljahel@auckland.ac.nz).R MC is Matthew Abel Professor of Economics at

the University of Auckland Business School (E-mail: r.macculloch@auckland.ac.nz). H S is

Senior Analyst at New Zealand Treasury (E-mail: hamed.shaee@treasury.govt.nz).

Received March 10, 2020; and accepted in revised form June 8, 2022.

Journal of Money, Credit and Banking, Vol. 55, No. 8 (December 2023)

© 2022 The Authors. Journal of Money, Credit and Banking published by Wiley Periodicals

LLC on behalf of Ohio State University.

This is an open access article under the terms of the Creative Commons Attribution License,

which permits use, distribution and reproduction in any medium, provided the original work

is properly cited.

2002 :MONEY,CREDIT AND BANKING

Furthermore, the Reserve Bank of New Zealand is required to implement monetary

policy in a way that promotes:

… the prosperity and well-being of New Zealanders. (Reserve Bank Monetary Policy

Amendment Act 2018)

While the primary objective of the European Central Bank is to maintain price sta-

bility, it is also required to contribute to the achievementof the aims of the European

Union, which include promoting the “well-being” of its citizens.1

This paper addresses the question of how to estimate a social welfare function de-

ned over ination and unemployment that can help inform the policy decisions of

central banks by providing a way to measure the well-being costs arising from macro-

economic uctuations. Consider the case of a Central Bank seeking to achieve price

stability in an economy which currently has a high-ination 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 ination 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 ination. One way to do so is by obtaining direct measurements of individual sub-

jective well-being from survey questions. These data can subsequently be correlated

with unemployment and ination rates in order to estimate the relative costs of these

variables.

An example of a direct measure of well-being is the “Cantril Ladder-of-Life” ques-

tion which asks each respondent to evaluate their life on a scale in which 0 is “the

worst possible life” and 10 is “the best possible life.” This question is regarded as

capturing the thoughts that people have about their whole life when they think about

it. A related survey question with a similar type of broad focus asks individuals to

evaluate whether, “on the whole,” they are “satised with the life they lead,” which

was used by Blanchower et al. (2014).

On the other hand, there is another dimension of well-being that relates more to

the emotional quality of an individual’s everyday experience that has been distin-

guished by recent research. Deaton and Kahneman (2010) nd that life evaluation

rises steadily with log income whereas there is no further progress in emotional well-

being beyond an annual income of U.S. $75,000. The emotions include the frequency

and intensity of a person’s experiences of joy and anger that make one’s day-to-day

life either pleasant or unpleasant.2This dimension is regarded as being associated

with instantaneous, or momentary, levels of well-being and has a short-term focus.

By contrast, the evaluation-of-life questions referred to above are regarded as having

1.For the European Central Bank’s enacting legislation, see https://european-union.europa.eu/

principles-countries-history/principles-and-values/aims-and-values_en

2.These pleasant and unpleasant emotions are sometimes referred to as “positive” and “negative”

affect when constructing measures of well-being (see Myers and Diener 1994).