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Raising the inflation target: What are the effective gains in policy room?

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  • L’Huillier, Jean-Paul
  • Schoenle, Raphael

Abstract

A macroeconomic setting characterized by higher inflation represents an opportunity to increase a central bank’s inflation target, which can mitigate the risk of future liquidity traps. We show that the gains generated by this strategy are not one-to-one: Because a higher inflation target leads to a steeper Phillips curve, to effectively get, for instance, 2 percentage points of extra room away from the zero lower bound on the interest rate, policymakers need to raise their inflation target from 2% to 5%. Taking this mechanism into consideration changes the optimal inflation target. When the natural rate is near zero, the optimal inflation target is 1 percentage point higher than the optimal target obtained by conventional, earlier, calculations.

Suggested Citation

  • L’Huillier, Jean-Paul & Schoenle, Raphael, 2026. "Raising the inflation target: What are the effective gains in policy room?," European Economic Review, Elsevier, vol. 187(C).
    • Handle: RePEc:eee:eecrev:v:187:y:2026:i:c:s0014292126000760
    DOI: 10.1016/j.euroecorev.2026.105332
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    Keywords

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    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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