Working Paper

The perils of nominal targets

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.

Keywords: Nominal targets; Monetary authority; Markov equilibria;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2014-02-04

Number: 14-2

Pages: 33 pages