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Average inflation targeting and economic volatility

Author

Listed:
  • Joshua Dennis Hall

    (Florida Southern College)

  • Peter V. Bias

    (Florida Southern College)

Abstract

The Federal Reserve announced that the interest rate targeting objective is to maintain an average inflation target (AIT) rate over time rather than an inflation target. What is the economic impact of moving from a constant inflation rate target to targeting an average inflation rate? A standard dynamic aggregate demand - aggregate supply (DAD-DAS) model is applied to run the simulations. Monetary policies are modeled by a DAD-DAS model using a monetary rate of growth targeting rule, and a classic Taylor rule in a baseline New Keynesian model. To model the AIT approach, a five-period moving average of inflation rate target (MAIT) is maintained as a short-run target, whereas, within the standard approach, a constant inflation target is maintained in the short- and long-run. As a robustness check, a canonical New Keynesian model is also used. Applying both supply and demand shocks to the simulation models, it is found that the MAIT approach increases economic volatility in both inflation and economic growth compared to the more standard objective constant inflation rate targeting.

Suggested Citation

  • Joshua Dennis Hall & Peter V. Bias, 2022. "Average inflation targeting and economic volatility," Economics Bulletin, AccessEcon, vol. 42(4), pages 2161-2170.
    • Handle: RePEc:ebl:ecbull:eb-22-00529
    as

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    File URL: http://www.accessecon.com/Pubs/EB/2022/Volume42/EB-22-V42-I4-P178.pdf
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    References listed on IDEAS

    as
    1. Nessen, Marianne & Vestin, David, 2005. "Average Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 837-863, October.
    2. Thomas M. Mertens & John C. Williams, 2019. "Tying Down the Anchor: Monetary Policy Rules and the Lower Bound on Interest Rates," Working Paper Series 2019-14, Federal Reserve Bank of San Francisco.
    3. David Reifschneider & David Wilcox, 2019. "Average Inflation Targeting Would Be a Weak Tool for the Fed to Deal with Recession and Chronic Low Inflation," Policy Briefs PB19-16, Peterson Institute for International Economics.
    4. Benjamin M. Friedman & Michael Woodford (ed.), 2010. "Handbook of Monetary Economics," Handbook of Monetary Economics, Elsevier, edition 1, volume 3, number 3.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Average Inflation Targeting; Monetary Policy; New Keynesian Model; Dynamic Aggregate Demand - Aggregate Supply Model;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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