The optimal inflation target and the natural rate of interest

We study how changes in the steady-state real interest rate (henceforth r*) affect the optimal inflation target in a New Keynesian dynamic stochastic general equilibrium (DSGE) model with trend inflation and a lower bound on the nominal interest rate. In this setup, a lower r* increases the probabil...

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Detalles Bibliográficos
Autores: Andrade, Philippe, Galí, Jordi, 1961-, Le Bihan, Hervé, Matheron, Julien
Tipo de recurso: artículo
Estado:Versión publicada
Fecha de publicación:2019
País:España
Institución:Universitat Pompeu Fabra
Repositorio:Repositorio Digital de la UPF
OAI Identifier:oai:repositori.upf.edu:10230/46934
Acceso en línea:http://hdl.handle.net/10230/46934
Access Level:acceso abierto
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spelling The optimal inflation target and the natural rate of interestAndrade, PhilippeGalí, Jordi, 1961-Le Bihan, HervéMatheron, JulienWe study how changes in the steady-state real interest rate (henceforth r*) affect the optimal inflation target in a New Keynesian dynamic stochastic general equilibrium (DSGE) model with trend inflation and a lower bound on the nominal interest rate. In this setup, a lower r* increases the probability of hitting the lower bound. That effect can be counteracted by an increase in the inflation target, but the resulting higher steady-state inflation has a welfare cost in and of itself. We use an estimated DSGE model to quantify that trade-off and determine the implied optimal inflation target, conditional on the monetary policy rule in place before the financial crisis. The relation between r* and the optimal inflation target is downward sloping. While the increase in the optimal inflation rate is in general smaller than the decline in r*, in the currently empirically relevant region the slope of the relation is found to be close to −1. That slope is robust to allowing for parameter uncertainty. Under makeup strategies such as price level targeting, the optimal inflation target is significantly lower and less sensitive to r*.Brookings Institution Press202120212019info:eu-repo/semantics/articleinfo:eu-repo/semantics/publishedVersionapplication/pdfapplication/pdfhttp://hdl.handle.net/10230/46934reponame:Repositorio Digital de la UPFinstname:Universitat Pompeu FabraInglésBrookings Papers on Economic Activity. 2019;Fall:173-255© Brookings Institution Press. https://www.brookings.edu/bpea-articles/the-optimal-inflation-target-and-the-natural-rate-of-interest/info:eu-repo/semantics/openAccessoai:repositori.upf.edu:10230/469342026-06-12T07:21:37Z
dc.title.none.fl_str_mv The optimal inflation target and the natural rate of interest
title The optimal inflation target and the natural rate of interest
spellingShingle The optimal inflation target and the natural rate of interest
Andrade, Philippe
title_short The optimal inflation target and the natural rate of interest
title_full The optimal inflation target and the natural rate of interest
title_fullStr The optimal inflation target and the natural rate of interest
title_full_unstemmed The optimal inflation target and the natural rate of interest
title_sort The optimal inflation target and the natural rate of interest
dc.creator.none.fl_str_mv Andrade, Philippe
Galí, Jordi, 1961-
Le Bihan, Hervé
Matheron, Julien
author Andrade, Philippe
author_facet Andrade, Philippe
Galí, Jordi, 1961-
Le Bihan, Hervé
Matheron, Julien
author_role author
author2 Galí, Jordi, 1961-
Le Bihan, Hervé
Matheron, Julien
author2_role author
author
author
description We study how changes in the steady-state real interest rate (henceforth r*) affect the optimal inflation target in a New Keynesian dynamic stochastic general equilibrium (DSGE) model with trend inflation and a lower bound on the nominal interest rate. In this setup, a lower r* increases the probability of hitting the lower bound. That effect can be counteracted by an increase in the inflation target, but the resulting higher steady-state inflation has a welfare cost in and of itself. We use an estimated DSGE model to quantify that trade-off and determine the implied optimal inflation target, conditional on the monetary policy rule in place before the financial crisis. The relation between r* and the optimal inflation target is downward sloping. While the increase in the optimal inflation rate is in general smaller than the decline in r*, in the currently empirically relevant region the slope of the relation is found to be close to −1. That slope is robust to allowing for parameter uncertainty. Under makeup strategies such as price level targeting, the optimal inflation target is significantly lower and less sensitive to r*.
publishDate 2019
dc.date.none.fl_str_mv 2019
2021
2021
dc.type.none.fl_str_mv info:eu-repo/semantics/article
info:eu-repo/semantics/publishedVersion
format article
status_str publishedVersion
dc.identifier.none.fl_str_mv http://hdl.handle.net/10230/46934
url http://hdl.handle.net/10230/46934
dc.language.none.fl_str_mv Inglés
language_invalid_str_mv Inglés
dc.relation.none.fl_str_mv Brookings Papers on Economic Activity. 2019;Fall:173-255
dc.rights.none.fl_str_mv info:eu-repo/semantics/openAccess
eu_rights_str_mv openAccess
dc.format.none.fl_str_mv application/pdf
application/pdf
dc.publisher.none.fl_str_mv Brookings Institution Press
publisher.none.fl_str_mv Brookings Institution Press
dc.source.none.fl_str_mv reponame:Repositorio Digital de la UPF
instname:Universitat Pompeu Fabra
instname_str Universitat Pompeu Fabra
reponame_str Repositorio Digital de la UPF
collection Repositorio Digital de la UPF
repository.name.fl_str_mv
repository.mail.fl_str_mv
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