This paper evaluates the effectiveness of monetary policy strategies alternative to inflation targeting (IT) when the natural interest rate is low ("new normal") and the probability that the policy rate hits its effective lower bound (ELB) is relatively high. We use a New Keynesian model calibrated to the euro area, and assume that the economy is hit by demand and supply shocks.
Strategies that compensate for persistent negative deviations of inflation from its target with positive deviations (price level targeting e average inflation targeting) are more effective than IT in stabilizing inflation and output and in reducing the probability to hit the ELB. The effectiveness of such strategies hinges on the central bank's commitment to keeping the policy rates low for long in response to deflationary shocks.
Published in 2021 in: Journal of Macroeconomics, v. 70.
