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Average inflation targeting and the interest rate lower bound

Taisuke Nakata, Sebastian Schmidt () and Flora Budianto

No 2394, Working Paper Series from European Central Bank

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. JEL Classification: E31, E52, E58, E61, E71

Keywords: deflationary bias; expectations; liquidity trap; makeup strategies; monetary policy objectives (search for similar items in EconPapers)
Date: 2020-04
New Economics Papers: this item is included in nep-mac and nep-mon
Note: 2179645
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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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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20202394

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