Abstract
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.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
