Working Paper: NBER ID: w17005
Authors: Bennett T. McCallum
Abstract: Should central banks, because of the zero-lower-bound problem, raise their inflation-rate targets? Several arguments are relevant. (1) In the absence of the ZLB, the optimal steady-state inflation rate, according to standard New Keynesian reasoning, lies between the Friedman-rule value of deflation at the steady-state real interest rate and the Calvo-model value of zero, with calibration indicating a larger weight on the latter. (2) An attractive modification of the Calvo pricing equation would, however, imply that the weight on the second of these values should be zero. (3) There may be some scope for activist monetary policy to be effective even when the one-period interest rate is at the ZLB; but there is professional disagreement on this matter. (4) Present institutional arrangements are not immutable. In particular, elimination of traditional currency is feasible (even arguably attractive) and would remove the ZLB constraint on policy. (5) Increasing target inflation for the purpose of avoiding occasional ZLB difficulties would tend to undermine the rationale for central bank independence and would constitute an additional movement away from policy recognition of the economic necessity for intertemporal discipline.
Keywords: Inflation Targets; Zero Lower Bound; Monetary Policy
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 |
|---|---|
| raising inflation targets (E31) | optimal steady-state inflation rate between Friedman rule value and Calvo model value (E31) |
| raising inflation targets (E31) | optimal inflation rate likely negative (E31) |
| ZLB constraints (E62) | effectiveness of activist monetary policy (E65) |
| elimination of traditional currency (E42) | removal of ZLB constraint on policy (E52) |
| increasing target inflation rate (E52) | undermining central bank independence (E58) |