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Joshua Dennis Hall and Peter V. Bias
''Average inflation targeting and economic volatility''
( 2022, Vol. 42 No.4 )
The Federal Reserve announced that the interest rate targeting objective is to maintain an average inflation target (AIT) rate over time rather than an inflation target. What is the economic impact of moving from a constant inflation rate target to targeting an average inflation rate? A standard dynamic aggregate demand - aggregate supply (DAD-DAS) model is applied to run the simulations. Monetary policies are modeled by a DAD-DAS model using a monetary rate of growth targeting rule, and a classic Taylor rule in a baseline New Keynesian model. To model the AIT approach, a five-period moving average of inflation rate target (MAIT) is maintained as a short-run target, whereas, within the standard approach, a constant inflation target is maintained in the short- and long-run. As a robustness check, a canonical New Keynesian model is also used. Applying both supply and demand shocks to the simulation models, it is found that the MAIT approach increases economic volatility in both inflation and economic growth compared to the more standard objective constant inflation rate targeting.
Keywords: Average Inflation Targeting, Monetary Policy, New Keynesian Model, Dynamic Aggregate Demand - Aggregate Supply Model
JEL: E4 - Money and Interest Rates: General
E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General
Manuscript Received : Jul 12 2022 Manuscript Accepted : Dec 30 2022

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