Inflation targeting, the zero lower bound and post-crisis monetary policy

https://nuxeo-ppd.univ-paris1.fr/nuxeo/site/esupversions/bc3b41b9-ca88-45d6-9076-1aed51d67740This paper addresses recent developments in monetary policy theory in the context of a binding Zero Lower Bound and discusses the possible evolution of monetary policy after the Great Recession. We start from Olivier Blanchard's suggestion that a higher inflation target and correspondingly higher interest rates would offer larger wiggle room for Central Banks to stimulate the economy through monetary easing without hitting the ZLB and might thus prove to be a desirable policy. Using a New-Keynesian DSGE framework and including positive steady state inflation, we investigate if having a higher permanent inflation target would improve welfare and find that this is unlikely. Furthermore, we address the possibility of having temporary higher inflation targets and the effect this could have on economic fundamentals. Finally, we discuss whether simple inflation targeting suffices or if monetary policy might evolve in the aftermath of the crisis towards including several objectives and/or instruments, so as to better respond to future economic downturns