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Approaching the terminal rate and the way forward: a model-based analysis

Author

Listed:
  • Anna Bartocci
  • Alessandro Cantelmo
  • Martina Cecioni
  • Christian Hoynck

    (Bank of Italy)

  • Alessandro Notarpietro

    (Bank of Italy)

  • Andrea Papetti

    (Bank of Italy)

Abstract
Using as a baseline a macroeconomic scenario consistent with the key interest rate path implied by market-based expectations, we evaluate the economic implications and risks of two alternative, illustrative tightening paths for the ECB policy rates that, as in the baseline, bring inflation toward 2 per cent by the end of 2025. We consider a prudent path (labelled 'persistent'), where policy rates are kept at current levels for a prolonged period and subsequently reduced more slowly, and a more pro-active approach ('peak') in which policy rates reach a higher terminal level, but decrease faster. Model-based simulations show that, relative to the baseline scenario, the persistent path would leave inflation and output unchanged in 2023-24, while the peak path would lower inflation at the cost of output losses. The persistent path would be preferable over the period 2023-25 according to a quadratic loss function penalizing inflation and output volatility. The risks of an excessive worsening of financing conditions and the amplification effects attached to the peak scenario are assessed to be greater than those of an upward de-anchoring of inflation expectations and of second-round effects associated with the persistent path.

Suggested Citation

  • Anna Bartocci & Alessandro Cantelmo & Martina Cecioni & Christian Hoynck & Alessandro Notarpietro & Andrea Papetti, 2023. "Approaching the terminal rate and the way forward: a model-based analysis," Questioni di Economia e Finanza (Occasional Papers) 791, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:opques:qef_791_23
    as

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    File URL: https://www.bancaditalia.it/pubblicazioni/qef/2023-0791/QEF_791_23.pdf
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    References listed on IDEAS

    as
    1. Levin, Andrew T. & Williams, John C., 2003. "Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 945-975, July.
    2. Stefano Neri & Guido Bulligan & Sara Cecchetti & Francesco Corsello & Andrea Papetti & Marianna Riggi & Concetta Rondinelli & Alex Tagliabracci, 2022. "On the anchoring of inflation expectations in the euro area," Questioni di Economia e Finanza (Occasional Papers) 712, Bank of Italy, Economic Research and International Relations Area.
    3. Athanasios Orphanides & John C. Williams, 2002. "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 63-146.
    4. Claudio Borio & Marco Jacopo Lombardi & James Yetman & Egon Zakrajsek, 2023. "The two-regime view of inflation," BIS Papers, Bank for International Settlements, number 133.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Central banking. monetary policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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