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Should central banks raise their inflation targets? Some relevant issues

  • Bennett T. McCallum

Several arguments are relevant. (1) In the absence of the zero lower bound (ZLB), the optimal steady-state inflation rate, according to standard reasoning, lies between 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 equation would imply that the weight on the second of these should be zero. (3) There may be some scope for monetary policy to be effective even at the ZLB. (4) Elimination of currency is feasible and would remove the ZLB constraint. (5) Increasing target inflation would undermine the rationale for central bank independence and constitute an additional movement away from intertemporal discipline.

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Article provided by Federal Reserve Bank of Richmond in its journal Economic Quarterly.

Volume (Year): (2011)
Issue (Month): 2Q ()
Pages: 111-131

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Handle: RePEc:fip:fedreq:y:2011:i:2q:p:111-131:n:v.97no.2
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  1. Bennett T. McCallum, 2000. "Theoretical analysis regarding a zero lower bound on nominal interest rates," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 870-935.
  2. Douglas Laxton & Dirk Muir & Michael Kumhof & Susanna Mursula & Charles Freedman, 2009. "Fiscal Stimulus to the Rescue? Short-Run Benefits and Potential Long-Run Costs of Fiscal Deficits," IMF Working Papers 09/255, International Monetary Fund.
  3. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
  4. Adam, Klaus & Billi, Roberto M., 2004. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Working Paper Series 0377, European Central Bank.
  5. Martin Feldstein, 2010. "What Powers for the Federal Reserve?," Journal of Economic Literature, American Economic Association, vol. 48(1), pages 134-145, March.
  6. John C. Williams, 2009. "Heeding Daedalus: Optimal inflation and the zero lower bound," Working Paper Series 2009-23, Federal Reserve Bank of San Francisco.
  7. Schmitt-Grohé, Stephanie & Uribe, Martín, 2010. "The Optimal Rate of Inflation," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 13, pages 653-722 Elsevier.
  8. Willem H. Buiter, 2009. "Negative Nominal Interest Rates: Three ways to overcome the zero lower bound," NBER Working Papers 15118, National Bureau of Economic Research, Inc.
  9. Michael Woodford, 2006. "How Important is Money in the Conduct of Monetary Policy?," Working Papers 1104, Queen's University, Department of Economics.
  10. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  11. Javier Andrés & David López-Salido & Edward Nelson, 2005. "Sticky-Price Models and the Natural Rate Hypothesis," Banco de Espa�a Working Papers 0521, Banco de Espa�a.
  12. Lars E.O. Svensson, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," NBER Working Papers 7957, National Bureau of Economic Research, Inc.
  13. Marvin Goodfriend & Bennett T. McCallum, 2007. "Banking and interest rates in monetary policy analysis: a quantitative exploration," Proceedings, Federal Reserve Bank of San Francisco.
  14. Marvin Goodfriend, 2007. "How the World Achieved Consensus on Monetary Policy," NBER Working Papers 13580, National Bureau of Economic Research, Inc.
  15. Goodfriend, Marvin, 2011. "Central banking in the credit turmoil: An assessment of Federal Reserve practice," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 1-12, January.
  16. Alan S. Blinder, 2010. "How Central Should the Central Bank Be?," Working Papers 1202, Princeton University, Department of Economics, Center for Economic Policy Studies..
  17. Goodfriend, Marvin, 2000. "Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1007-35, November.
  18. David Reifschneider & John C. Williams, 1999. "Three lessons for monetary policy in a low inflation era," Finance and Economics Discussion Series 1999-44, Board of Governors of the Federal Reserve System (U.S.).
  19. Roberto M. Billi, 2007. "Optimal inflation for the U.S," Research Working Paper RWP 07-03, Federal Reserve Bank of Kansas City.
  20. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  21. McCallum, Bennett T., 2008. "Reconsideration of the P-bar model of gradual price adjustment," European Economic Review, Elsevier, vol. 52(8), pages 1480-1493, November.
  22. Greenfield, Robert L & Yeager, Leland B, 1983. "A Laissez-Faire Approach to Monetary Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 15(3), pages 302-15, August.
  23. Willem H. Buiter, 2003. "Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap," NBER Working Papers 10163, National Bureau of Economic Research, Inc.
  24. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
  25. Woodford, Michael, 2005. "Comment on: "Using a long-term interest rate as the monetary policy instrument"," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 881-887, July.
  26. Bruce McGough & Glenn D. Rudebusch & John C. Williams, 2004. "Using a long-term interest rate as the monetary policy instrument," Working Paper Series 2004-22, Federal Reserve Bank of San Francisco.
  27. Peter J. Wallison, 2010. "Government Housing Policy and the Financial Crisis," Cato Journal, Cato Journal, Cato Institute, vol. 30(2), pages 397-406, Spring.
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  29. Rudiger Dornbusch, 1980. "Exchange Rate Economics: Where Do We Stand?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 143-206.
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