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Average inflation targeting and the interest rate lower bound

Flora Budianto, Taisuke Nakata and Sebastian Schmidt ()

No 852, BIS Working Papers from Bank for International Settlements

Abstract: Assigning a discretionary central bank a mandate to stabilize an average inflation rate - rather than a period-by-period inflation rate - increases welfare in a New Keynesian model with an occasionally binding lower bound on nominal interest rates. Under rational expectations, the welfare-maximizing averaging window is infinitely long, which means that optimal average inflation targeting (AIT) is equivalent to price level targeting (PLT). However, AIT with a finite, but sufficiently long, averaging window can attain most of the welfare gain from PLT. Under boundedly-rational expectations, if cognitive limitations are sufficiently strong, the optimal averaging window is finite, and the welfare gain of adopting AIT can be small.

Keywords: monetary policy objectives; makeup strategies; liquidity trap; deflationary bias; expectations (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 E61 E71 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2020-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Related works:
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
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