TY - JOUR
T1 - Monetary Policy with a State-Dependent Inflation Target in a Behavioral Two-Country Monetary Union Model
AU - Proano, Christian R
AU - Lojak, Benjamin
PY - 2021
Y1 - 2021
N2 - In this paper we study the implementation of a state-dependent inflation target in a two-country monetary union model characterized by boundedly rational agents. In particular, we use the spread between the actual policy rate (which is constrained by the zero-lower-bound) and the Taylor rate (which can become negative) as a measure for the degree of ineffectiveness of conventional monetary policy as a stabilizing mechanism. The perception of macroeconomic risk by the agents is assumed to vary according to this measure by means of the Brock-Hommes switching mechanism. Our numerical simulations indicate a) that a state-dependent inflation target may lead to a better macroeconomic and inflation stabilization, and b) may even lead to an enlarged fiscal space, i.e. a lower debt-to-GDP ratio if the risk premium's reaction to a higher inflation target is not too large.
AB - In this paper we study the implementation of a state-dependent inflation target in a two-country monetary union model characterized by boundedly rational agents. In particular, we use the spread between the actual policy rate (which is constrained by the zero-lower-bound) and the Taylor rate (which can become negative) as a measure for the degree of ineffectiveness of conventional monetary policy as a stabilizing mechanism. The perception of macroeconomic risk by the agents is assumed to vary according to this measure by means of the Brock-Hommes switching mechanism. Our numerical simulations indicate a) that a state-dependent inflation target may lead to a better macroeconomic and inflation stabilization, and b) may even lead to an enlarged fiscal space, i.e. a lower debt-to-GDP ratio if the risk premium's reaction to a higher inflation target is not too large.
U2 - 10.1016/j.jedc.2021.104236
DO - 10.1016/j.jedc.2021.104236
M3 - Article
SN - 0165-1889
VL - 133
JO - Journal of Economic Dynamics and Control
JF - Journal of Economic Dynamics and Control
ER -