The Perils of Nominal Targets

Roc Armenter

Executive Vice President, Economist, and Director of Research and of the Consumer Finance Institute

October 2016

WP 16-30 — A monetary authority can be committed to pursuing an inflation, price-level, or nominal-GDP target yet systematically fail to achieve the prescribed goal.

Supersedes Working Paper 14-2/R - The Perils of Nominal Targets.

Constrained by the zero lower bound on the policy rate, the monetary authority is unable to implement its objectives when private-sector expectations stray far enough from the target. Low-inflation expectations become self-fulfilling, resulting in an additional Markov equilibrium in which the monetary authority falls short of the nominal target, average output is below its efficient level, and the policy rate is typically low. Introducing a stabilization goal for long-term nominal rates can implement a unique Markov equilibrium without fully compromising stabilization policy.

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