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UBC Theses and Dissertations

Essays in optimal monetary policy Franz Pattillo, Nicolas


This research delves into the factors shaping inflation targeting. Chapter 1 details the way the literature has evolved. Chapter 2 reveals significant insights into the interplay between a monetary authority’s commitment and the zero lower bound (ZLB) on nominal interest rates. The study unveils that monopolistic inefficiency can lead to increased optimal inflation under discretion (inflation bias), and the emergence of the ZLB can improve welfare in all commitment levels by lowering inflation expectations. Chapter 2 asserts that the effectiveness of forward guidance versus higher inflation during ZLB scenarios is contingent on the level of commitment by the monetary authority. In highly committed economies, where for- ward guidance is more efficient, inflation can be kept low and selectively increased during ZLB episodes. This strategic inflation management can lower the duration and likelihood of hitting the ZLB. Consequently, com- mitted economies experience lower and less volatile inflation. In contrast, economies with high discretionary tendencies and ineffective forward guidance reduce the likelihood of the ZLB, through higher inflation rates. Nonetheless, economies show better welfare outcomes with increased commitment. The paper also identifies an intriguing non-homogeneous relationship between the probability of hitting the ZLB and the level of commitment. It shows that a fully committed economy is less likely to encounter the ZLB, experience lower variance in inflation, and achieve higher consumption and overall welfare compared to an almost fully committed one. Chapter 3 scrutinizes the optimal inflation target, utilizing a small New- Keynesian model, and its link with the ZLB on nominal interest rates. This research argues that a high inflation target helps avoid the ZLB without in- creasing welfare loss only when the free-of-cost inflation is close to the target. Despite theoretical models suggesting negative or zero targets, real-world data consistently display positive targets, often around 2%. This Chapter shows that a target around that level significantly reduces the likelihood of hitting the ZLB, and is optimal provided the free-of-cost price adjustment is near 1.6%. By highlighting these findings, this dissertation enhances our under- standing of inflation targeting, commitment levels, and their implications for monetary policy.

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