The Perils of Nominal Targets
53 Pages Posted: 11 Nov 2016
Date Written: 2016-11-10
A monetary authority can be committed to pursuing an inflation, price-level, or nominal-GDP target yet systematically fail to achieve the prescribed goal. Constrained by the zero lower bound on the policy rate, the monetary authority is unable to implement its objectives when private-sector expectations stray far enough from the target. Low-inflation expectations become self-fulfilling, resulting in an additional Markov equilibrium in which the monetary authority falls short of the nominal target, average output is below its efficient level, and the policy rate is typically low. Introducing a stabilization goal for long-term nominal rates can implement a unique Markov equilibrium without fully compromising stabilization policy.
Keywords: inflation targeting, zero lower bound, Markov equilibria
JEL Classification: E52, E58
Suggested Citation: Suggested Citation