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

55 Pages Posted: 19 Jun 2020

See all articles by Jean-Paul L'Huillier

Jean-Paul L'Huillier

Brandeis University; Federal Reserve Bank of Cleveland

Raphael Schoenle

Brandeis University

Multiple version iconThere are 2 versions of this paper

Date Written: June 16, 2020

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

JEL Classification: E31, E52, E58

Suggested Citation

L'Huillier, Jean-Paul and Schoenle, Raphael, Raising the Inflation Target: How Much Extra Room Does It Really Give? (June 16, 2020). FRB of Cleveland Working Paper No. 20-16, Available at SSRN: https://ssrn.com/abstract=3628800 or http://dx.doi.org/10.2139/ssrn.3628800

Jean-Paul L'Huillier

Brandeis University ( email )

Waltham, MA 02454-9110
United States

HOME PAGE: http://https://sites.google.com/site/jplhuill/

Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Raphael Schoenle (Contact Author)

Brandeis University ( email )

Waltham, MA 02454
United States

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