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The perils of nominal targets

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  • Armenter, Roc

    (Federal Reserve Bank of Philadelphia)

Abstract

A monetary authority can be committed to pursuing an inflation, price-level, or nominal output target yet systematically fail to achieve the specified goals. Constrained by the zero lower bound on the policy rate, the monetary authority is unable to implement its objectives when private-sector expectations stray away from the target in the first place. Low-inflation expectations become self-fulfilling, leading to multiple Markov equilibria. Private-sector expectations are anchored on a unique Markov equilibrium if the monetary authority is given a strong stabilization goal for the policy rate. However, policy-rate stabilization may not improve welfare as the resulting policy is severely distorted.

Suggested Citation

  • Armenter, Roc, 2013. "The perils of nominal targets," Working Papers 14-2, Federal Reserve Bank of Philadelphia, revised 04 Feb 2014.
  • Handle: RePEc:fip:fedpwp:14-2
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    References listed on IDEAS

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    Cited by:

    1. Contessi, Silvio & Li, Li & De Pace, Pierangelo, 2014. "An international perspective on the recent behavior of inflation," Review, Federal Reserve Bank of St. Louis, vol. 96(3), pages 267-294.
    2. repec:wly:jmoncb:v:49:y:2017:i:2-3:p:393-415 is not listed on IDEAS
    3. S Borağan Aruoba & Pablo Cuba-Borda & Frank Schorfheide, 2018. "Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries," Review of Economic Studies, Oxford University Press, vol. 85(1), pages 87-118.
    4. Hills, Timothy S. & Nakata, Taisuke & Schmidt, Sebastian, 2016. "The Risky Steady State and the Interest Rate Lower Bound," Finance and Economics Discussion Series 2016-9, Board of Governors of the Federal Reserve System (U.S.).
    5. Nakata, Taisuke, 2016. "Optimal fiscal and monetary policy with occasionally binding zero bound constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 220-240.
    6. Nakata, Taisuke & Schmidt, Sebastian, 2014. "Conservatism and Liquidity Traps," Finance and Economics Discussion Series 2014-105, Board of Governors of the Federal Reserve System (U.S.).
    7. Michael Ehrmann, 2015. "Targeting Inflation from Below: How Do Inflation Expectations Behave?," International Journal of Central Banking, International Journal of Central Banking, vol. 11(4), pages 213-249, September.
    8. Ragna Alstadheim & Øistein Røisland, 2017. "When Preferences for a Stable Interest Rate Become Self‐Defeating," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(2-3), pages 393-415, March.
    9. Narayana R. Kocherlakota, 2016. "Sluggish Inflation Expectations: A Markov Chain Analysis," NBER Working Papers 22009, National Bureau of Economic Research, Inc.
    10. Holden, Thomas, 2016. "Existence and uniqueness of solutions to dynamic models with occasionally binding constraints," EconStor Preprints 130142, ZBW - German National Library of Economics.
    11. Duarte, Fernando M. & Zabai, Anna, 2015. "An interest rate rule to uniquely implement the optimal equilibrium in a liquidity trap," Staff Reports 745, Federal Reserve Bank of New York.

    More about this item

    Keywords

    Nominal targets; Monetary authority; Markov equilibria;

    JEL classification:

    • 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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