Approaching the terminal rate and the way forward: a model-based analysis

Anna Bartocci, Alessandro Cantelmo, Martina Cecioni (), Christian Hoynck (), Alessandro Notarpietro and Andrea Papetti
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Christian Hoynck: Bank of Italy

No 791, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: Using as a baseline a macroeconomic scenario consistent with the key interest rate path implied by market-based expectations, we evaluate the economic implications and risks of two alternative, illustrative tightening paths for the ECB policy rates that, as in the baseline, bring inflation toward 2 per cent by the end of 2025. We consider a prudent path (labelled 'persistent'), where policy rates are kept at current levels for a prolonged period and subsequently reduced more slowly, and a more pro-active approach ('peak') in which policy rates reach a higher terminal level, but decrease faster. Model-based simulations show that, relative to the baseline scenario, the persistent path would leave inflation and output unchanged in 2023-24, while the peak path would lower inflation at the cost of output losses. The persistent path would be preferable over the period 2023-25 according to a quadratic loss function penalizing inflation and output volatility. The risks of an excessive worsening of financing conditions and the amplification effects attached to the peak scenario are assessed to be greater than those of an upward de-anchoring of inflation expectations and of second-round effects associated with the persistent path.

Keywords: Central; banking.; monetary; policy (search for similar items in EconPapers)
JEL-codes: E52 E58 E61 (search for similar items in EconPapers)
Date: 2023-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:bdi:opques:qef_791_23

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