Discussion Paper Details

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Title: On Robustness of Average Inflation Targeting

Author(s): Seppo Honkapohja and Nigel McClung

Publication Date: April 2021

Keyword(s): Adaptive Learning, Inflation targeting and Zero Interest Rate Lower Bound

Programme Area(s): Monetary Economics and Fluctuations

Abstract: This paper considers the performance of average inflation targeting (AIT) policy in a New Keynesian model with adaptive learning agents. Our analysis raises concerns regarding robustness of AIT when agents have imperfect knowledge. In particular, the target steady state can be locally unstable under learning if details about the policy are not publicly available. Near the low steady state with interest rates at the zero lower bound, AIT does not necessarily outperform a standard inflation targeting policy. Policymakers can improve outcomes under AIT by (i) targeting a discounted average of inflation, or (ii) communicating the data window for the target.

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Bibliographic Reference

Honkapohja, S and McClung, N. 2021. 'On Robustness of Average Inflation Targeting'. London, Centre for Economic Policy Research.