Working Paper: CEPR ID: DP16001
Authors: Seppo Honkapohja; Nigel McClung
Abstract: This paper considers the performance of average inflation targeting(AIT) policy in a New Keynesian model with adaptive learning agents.Our analysis raises concerns regarding robustness of AIT when agentshave imperfect knowledge. In particular, the target steady state canbe locally unstable under learning if details about the policy are notpublicly available. Near the low steady state with interest rates atthe zero lower bound, AIT does not necessarily outperform a standardinflation targeting policy. Policymakers can improve outcomesunder AIT by (i) targeting a discounted average of inflation, or (ii)communicating the data window for the target.
Keywords: adaptive learning; inflation targeting; zero interest rate lower bound
JEL Codes: E31; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lack of transparency in AIT (D82) | Instability in economic outcomes (D59) |
| Imperfect knowledge and learning (D83) | Locally unstable target steady states under AIT (C62) |
| Policy modifications (D78) | Improved economic performance (O49) |
| Price stickiness and speed of agents' learning (C54) | Stability of target steady state under AIT (C62) |
| AIT performance (C67) | Influenced by opacity of its details (Y60) |