Average Inflation Targeting in a Behavioral Heterogeneous Agent New Keynesian Model

Abstract

We analyze the optimal window length in the average inflation targeting rule within a Behavioral THANK model. The central bank faces an occasionally binding effective lower bound (ELB) or persistent supply shocks, and can also use quantitative easing. We show that the optimal averaging period is infinitely long in the case of a conventional degree of myopia. Finite yet long-lasting windows dominate for higher cognitive discounting. We solve the model both locally and globally to disentangle the effects of uncertainty about hitting the ELB in the future, which leads to a downward inflation bias for the global solution. The welfare loss difference between solution techniques is considerably decreasing in the degree of history dependence.

Appendix available https://ssrn.com/abstract=4359563

Keywords: Monetary Policy, Average Inflation Targeting, Heterogeneous Agents, Behavioral Macroeconomics

JEL Classification: E31, E32, E52, E58, E71