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Could a Higher Inflation Target Enhance Macroeconomic Stability?

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

Staff Working Papers from Bank of Canada

Abstract: Recent international experience with the effective lower bound on nominal interest rates has rekindled interest in the benefits of inflation targets above 2 per cent. We evaluate whether an increase in the inflation target to 3 or 4 per cent 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.

Keywords: Economic models; Inflation targets; Monetary policy framework (search for similar items in EconPapers)
JEL-codes: E32 E37 E43 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2018
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Journal Article: Could a higher inflation target enhance macroeconomic stability? (2018) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:18-17

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