Monetary Policy with a State-Dependent Inflation Target in a Behavioral Two-Country Monetary Union Model

Christian Proaño and Benjamin Lojak

Journal of Economic Dynamics and Control, 2021, vol. 133, issue C

Abstract: In this paper we study the implementation of a state-dependent inflation target in a two-country monetary union model characterized by boundedly rational agents. In particular, we use the spread between the actual policy rate (which is constrained by the zero-lower-bound) and the Taylor rate (which can become negative) as a measure for the degree of ineffectiveness of conventional monetary policy as a stabilizing mechanism. The perception of macroeconomic risk by the agents is assumed to vary according to this measure by means of the Brock-Hommes switching mechanism. Our numerical simulations indicate a) that a state-dependent inflation target may lead to a better macroeconomic and inflation stabilization, and b) may even lead to an enlarged fiscal space, i.e. a lower debt-to-GDP ratio if the risk premium’s reaction to a higher inflation target is not too large.

Keywords: Monetary Policy; Monetary Unions; Zero Lower Bound; Inflation Targets; Behavioral Macroeconomics (search for similar items in EconPapers)
JEL-codes: E52 E7 F02 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Monetary policy with a state-dependent inflation target in a behavioral two-country monetary union model (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:133:y:2021:i:c:s0165188921001718

DOI: 10.1016/j.jedc.2021.104236

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