Template-Type: ReDIF-Paper 1.0
Author-Name: Flora Budianto
Author-X-Name-First: Flora
Author-X-Name-Last: Budianto
Author-Name: Taisuke Nakata
Author-X-Name-First: Taisuke
Author-X-Name-Last: Nakata
Author-Name: Sebastian Schmidt
Author-X-Name-First: Sebastian
Author-X-Name-Last: Schmidt
Title: Average inflation targeting and the interest rate lower bound
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.
Length: 29 pages
Creation-Date: 2020-04
File-URL: https://www.bis.org/publ/work852.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work852.htm
File-Format: text/html
Number: 852
Classification-JEL: E31, E52, E58, E61, E71
Keywords: monetary policy objectives, makeup strategies, liquidity trap, deflationary bias, expectations
Handle: RePEc:bis:biswps:852