 Optimal Disinflation and ReflationNo 2023-01, Working Papers from Department of Economics, Colgate University Abstract: This paper presents an alternative foundation to the standard quadratic loss function characterizing central bank inflation policy. The alternative treats high employment as a social benefit. In recognition of the inherent asymmetry of the output gap, two self-imposed constraints provide guardrails that rule out excess unemployment and opportunistic reflation. The loss function includes a novel reverse discounting mechanism that penalizes the bank for more sustained inflation gaps that could undermine confidence and reduce inflation expectations anchoring. Anchoring shapes the way the bank manages inflation expectations. In the absence of anchoring the shadow price of expectations is equal to the sacrifice ratio but in the presence of anchoring the shadow price drops to zero reflecting the policy flexibility anchoring affords the central bank. The central bank’s optimal policy differs dramatically from the standard Taylor Rule recommendation in choosing policy plans with higher employment, in its willingness to overshoot inflation targets, and in avoiding excess unemployment, all while observing the discipline needed for successful inflation targeting. JEL-codes: E31 (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:cgt:wpaper:2023-01 Access Statistics for this paper More papers in Working Papers from Department of Economics, Colgate University Contact information at EDIRC. |
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