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Monetary policy strategies in the New Normal: a model-based analysis for the euro area

Author

Listed:
  • Fabio Busetti
  • Stefano Neri

    (Bank of Italy)

  • Alessandro Notarpietro

    (Bank of Italy)

  • Massimiliano Pisani

    (Bank of Italy)

Abstract

A New Keynesian model calibrated to the euro area is used to evaluate the stabilization properties of alternative monetary policy strategies when the natural interest rate is low (‘new normal’) and the probability of reaching the effective lower bound (ELB) is non-negligible. Price level targeting is the most effective strategy in terms of stabilizing inflation and output and of reducing the duration and frequency of ELB episodes. Temporary price level targeting is also effective in mitigating the ELB constraint, although its stabilization properties are inferior to those of price level targeting. Backward-looking average inflation targeting performs well and is preferable to inflation targeting. The effectiveness of these alternative strategies hinges upon the commitment of a central bank to keeping the policy rate ‘lower for longer’ and is influenced by the agents’ expectation formation mechanism.

Suggested Citation

  • Fabio Busetti & Stefano Neri & Alessandro Notarpietro & Massimiliano Pisani, 2020. "Monetary policy strategies in the New Normal: a model-based analysis for the euro area," Temi di discussione (Economic working papers) 1308, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_1308_20
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    monetary policy; natural interest rate; effective lower bound.;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • 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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