Raising the Inflation Target: How Much Extra Room Does It Really Give?

Jean-Paul L'Huillier and Raphael Schoenle

No 20-16, Working Papers from Federal Reserve Bank of Cleveland

Abstract: Some, but less than intended. The reason is a shift in the behavior of the private sector: Prices adjust more frequently, lowering the potency of monetary policy. We quantitatively investigate this channel across different models, based on a calibration using micro data. By raising the target from 2 percent to 4 percent, the monetary authority gets only between 0.51 and 1.60 percentage points of effective extra policy room for monetary policy (not 2 percentage points as intended). Getting 2 percentage points of effective extra room requires raising the target to more than 4 percent. Taking this channel into consideration raises the optimal inflation target by roughly 1 percentage points relative to earlier computations.

Keywords: timidity trap; zero lower bound; liquidity traps; central bank design; inflation targeting; Lucas proof; price stability (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Pages: 55
Date: 2020-06-16
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (3)

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Working Paper: Raising the Inflation Target: How Much Extra Room Does It Really Give? (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedcwq:88168

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DOI: 10.26509/frbc-wp-202016

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