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Raising the Inflation Target: How Much Extra Room Does It Really Give?

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  • Jean-Paul L'Huillier
  • Raphael Schoenle

Abstract

Some, but less than intended. The reason is a shift in the behavior of the private sector: Prices adjust more frequently, lowering the potency of monetary policy. We quantitatively investigate this channel across different models, based on a calibration using micro data. By raising the target from 2 percent to 4 percent, the monetary authority gets only between 0.51 and 1.60 percentage points of effective extra policy room for monetary policy (not 2 percentage points as intended). Getting 2 percentage points of effective extra room requires raising the target to more than 4 percent. Taking this channel into consideration raises the optimal inflation target by roughly 1 percentage points relative to earlier computations.

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  • Jean-Paul L'Huillier & Raphael Schoenle, 2020. "Raising the Inflation Target: How Much Extra Room Does It Really Give?," Working Papers 20-16, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwq:88168
    DOI: 10.26509/frbc-wp-202016
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    Cited by:

    1. Adam, Klaus & Gautier, Erwan & Santoro, Sergio & Weber, Henning, 2022. "The case for a positive euro area inflation target: Evidence from france, germany and italy," Journal of Monetary Economics, Elsevier, vol. 132(C), pages 140-153.
    2. Philippe Andrade & Jordi Gali & Hervé Le Bihan & Julien Matheron, 2021. "Should the ECB Adjust Its Strategy in the Face of a Lower r*?," Working Papers 22-1, Federal Reserve Bank of Boston.
    3. repec:zbw:bofrdp:2022_007 is not listed on IDEAS
    4. Christopher D. Cotton, 2020. "The Inflation Target and the Equilibrium Real Rate," Working Papers 20-2, Federal Reserve Bank of Boston.
    5. Clayton, Christopher & Schaab, Andreas, 2022. "A Theory of Dynamic Inflation Targets," TSE Working Papers 22-1389, Toulouse School of Economics (TSE).
    6. Andrade, Philippe & Galí, Jordi & Le Bihan, Hervé & Matheron, Julien, 2021. "Should the ECB adjust its strategy in the face of a lower r★?," Journal of Economic Dynamics and Control, Elsevier, vol. 132(C).
    7. Ambrocio, Gene & Ferrero, Andrea & Jokivuolle, Esa & Ristolainen, Kim, 2022. "What Should the Inflation Target Be? Views from 600 Economists," CEPR Discussion Papers 17289, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    timidity trap; zero lower bound; liquidity traps; central bank design; inflation targeting; Lucas proof; price stability;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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