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Could a higher inflation target enhance macroeconomic stability?

José Dorich, Nicholas Labelle St-Pierre, Vadym Lepetyuk and Rhys Mendes ()

Canadian Journal of Economics, 2018, vol. 51, issue 3, 1029-1055

Abstract: Recent international experience with the effective lower bound on nominal interest rates has rekindled interest in the benefits of inflation targets above 2%. We evaluate whether an increase in the inflation target to 3% or 4% could improve macroeconomic stability in the Canadian economy. We find that the magnitude of the benefits hinges critically on two elements: (i) the availability and effectiveness of unconventional monetary policy (UMP) tools at the effective lower bound and (ii) the level of the real neutral interest rate. In particular, we show that when the real neutral rate is in line with the central tendency of estimates, raising the inflation target yields some improvement in macroeconomic outcomes. There are only modest gains if effective UMP tools are available. In contrast, with a deeply negative real neutral rate, a higher inflation target substantially improves macroeconomic stability regardless of UMP.

JEL-codes: E32 (search for similar items in EconPapers)
Date: 2018
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