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Optimal inflation target with expectations-driven liquidity traps

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  • Coyle, Philip
  • Nakata, Taisuke

Abstract

In expectations-driven liquidity traps (LTs), a higher inflation target is associated with lower inflation and consumption. As a result, introducing the possibility of expectations-driven LTs to an otherwise standard model lowers the optimal inflation target. Using a calibrated New Keynesian model with an effective lower bound (ELB) constraint on nominal interest rates, we find that even a very small probability of falling into an expectations-driven LT lowers the optimal inflation target nontrivially. Our analysis provides a novel reason to be cautious about the argument that central banks should raise their inflation targets in light of a higher likelihood of hitting the ELB.

Suggested Citation

  • Coyle, Philip & Nakata, Taisuke, 2026. "Optimal inflation target with expectations-driven liquidity traps," Macroeconomic Dynamics, Cambridge University Press, vol. 30, pages 1-1, January.
    • Handle: RePEc:cup:macdyn:v:30:y:2026:i::p:-_44
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