EconPapers    
Economics at your fingertips  
 

Average Inflation Targeting and the Interest Rate Lower Bound

Sebastian Schmidt, Flora Budianto and Taisuke Nakata

No 14400, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Under conventional inflation targeting (IT), the lower bound on nominal interest rates gives rise to a systematic downward bias in inflation that substantially reduces welfare. Using two variants of a New Keynesian model, we investigate whether a monetary policy strategy that aims to stabilize an average inflation rate---rather than a period-by-period inflation rate---leads to better outcomes. With rational expectations, price level targeting (PLT)---the limiting case of average inflation targeting (AIT)---is optimal, yet AIT with sufficient history dependence reaps most of the benefits of PLT. With boundedly rational expectations, PLT is no longer optimal unless the degree of bounded rationality is small. When deviations from rational expectations are sufficiently large, outcomes can be worse under PLT or AIT with strong history dependence than under IT. Finally, for both variants of the model, inflation conservatism improves welfare by eliminating the deflationary bias without invoking history dependence.

Keywords: Monetary policy objectives; Makeup strategies; Liquidity trap; Deflationary bias (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 E61 E71 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (32)

Downloads: (external link)
https://cepr.org/publications/DP14400 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: Average inflation targeting and the interest rate lower bound (2023) Downloads
Working Paper: Average inflation targeting and the interest rate lower bound (2020) Downloads
Working Paper: Average Inflation Targeting and the Interest Rate Lower Bound (2020) Downloads
Working Paper: Average inflation targeting and the interest rate lower bound (2020) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:14400

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP14400

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().

 
Page updated 2025-03-31
Handle: RePEc:cpr:ceprdp:14400