Exuberance

The paper argues that inflation targeting is an insufficient framework for monetary policy in the presence of financial exuberance. It also argues that current theoretical rationalizations of inflation targeting are flawed, being unable to explain why central banks should aim for “low” inflation. A low inflation target can be justified if monetary policy is placed in a backward bending Phillips curve model, in which case policy should target the minimum unemployment rate of inflation (MURI). However, inflation targeting cannot address the problem of debt bubbles. This suggests that it should be paired with private sector balance sheet regulations that give central banks additional instruments to tackle asset market instabilities