Working Paper

Hitting the Elusive Inflation Target

Abstract: Since the 2001 recession, average core inflation has been below the Federal Reserve?s 2% target. This deflationary bias is a predictable consequence of a low nominal interest rates environment in which the central bank follows a symmetric strategy to stabilize inflation. The deflationary bias increases if macroeconomic uncertainty rises or the natural real interest rate falls. An asymmetric rule according to which the central bank responds less aggressively to above-target inflation corrects the bias and allows inflation to converge to the central bank?s target. We show that adopting this asymmetric rule improves welfare and reduces the risk of self-fulfilling deflationary spirals. This approach does not entail any history dependence in setting the policy rate or any commitment to overshoot inflation after periods in which the lower bound constraint was binding.

Keywords: Deflationary bias; asymmetric rules; opportunistic reflation; welfare; natural rates; zero lower bound; disanchoring of inflation expectations; inflation targeting; liquidity traps; macroeconomic uncertainty;

JEL Classification: D83; E31; E52; E62; E63;

https://doi.org/10.21033/wp-2019-07

Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 2019-08-30

Number: WP-2019-7

Pages: 40 pages