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Nominal GDP Targeting and the Zero Lower Bound: Should We Abandon Inflation Targeting?

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  • Billi, Roberto M.

    (Research Department, Central Bank of Sweden)

Abstract

I compare nominal GDP level targeting to flexible inflation targeting in a small New Keynesian model subject to the zero lower bound on nominal policy rates. First, I study the performance of optimal discretionary policies. I find that, for a standard calibration, inflation targeting under discretion leaves the economy open to a deflationary trap. Nominal GDP level targeting under discretion, by contrast, provides a firm nominal anchor to the economy. Second, I study simple policy rules and the role of smoothing in the rules. With smoothing, a Taylor-type rule performs as well as a nominal GDP level rule. These result suggest that inflation targeting should not be ditched. Still, it can be improved significantly, by using policy rate smoothing to anchor inflation firmly.

Suggested Citation

  • Billi, Roberto M., 2013. "Nominal GDP Targeting and the Zero Lower Bound: Should We Abandon Inflation Targeting?," Working Paper Series 270, Sveriges Riksbank (Central Bank of Sweden).
  • Handle: RePEc:hhs:rbnkwp:0270
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    References listed on IDEAS

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    1. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
    2. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
    3. Roberto M. Billi, 2011. "Optimal Inflation for the US Economy," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 29-52, July.
    4. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
    5. Taylor, John B. & Williams, John C., 2010. "Simple and Robust Rules for Monetary Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 15, pages 829-859, Elsevier.
    6. John C. Williams, 2009. "Heeding Daedalus: Optimal Inflation and the Zero Lower Bound," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(2 (Fall)), pages 1-49.
    7. Benjamin M. Friedman & Michael Woodford (ed.), 2010. "Handbook of Monetary Economics," Handbook of Monetary Economics, Elsevier, edition 1, volume 3, number 3.
    8. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 145-166, Fall.
    9. 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.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    nominal GDP target; optimal policy; simple rules; zero lower bound;
    All these keywords.

    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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