Inflation tolerance ranges in the New Keynesian model

Hervé Le Bihan, Magali Marx and Julien Matheron

European Economic Review, 2023, vol. 153, issue C

Abstract: A number of central banks in advanced countries use ranges, or bands, around their inflation target to formulate their monetary policy strategy. The adoption of such ranges has been proposed by some policymakers in the context of the Fed and the ECB reviews of their strategies. Using a standard New Keynesian macroeconomic model, we analyze the consequences of tolerance range policies, characterized by a stronger reaction of the central bank to inflation when inflation lies outside the range, than when it is close to the target, i.e. the central value of the band. We show that (i) a tolerance band should not be a zone of inaction: the lack of reaction may trigger substantial unwarranted volatility and lead to multiple equilibria; (ii) the trade-off between the reaction needed outside the range versus inside appears unfavorable: a very strong reaction, when inflation is far from the target, is required to compensate for a moderately lower reaction within tolerance band; (iii) these results, obtained within the framework of a stylized model, are robust to many alterations, in particular allowing for the zero lower bound.

Keywords: Monetary policy; Inflation range; Zero lower bound; Regime switching (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Inflation tolerance ranges in the New Keynesian model (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:153:y:2023:i:c:s0014292123000272

DOI: 10.1016/j.euroecorev.2023.104398

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