Must-Read: Marc Dordal i Carreras, Olivier Coibion, Yuriy Gorodnichenko, and Johannes Wieland: Rethinking Inflation Targets for Long ZLB Episodes

Must-Read: Marc Dordal i Carreras, Olivier Coibion, Yuriy Gorodnichenko, and Johannes Wieland: Rethinking Inflation Targets for Long ZLB Episodes:

The estimated frequencies and durations are quite sensitive to individual country experiences…

For example, excluding Japan reduces the frequency and duration to 6% and just under three years respectively, lowering the optimal rate of inflation to 2% per year. Excluding the period 1968-1984 when inflation and nominal interest rates were too high for the ZLB to be practically reached, on the other hand, raises the estimated frequency and duration of ZLB episodes to 10% and four and half years respectively, thereby raising the optimal inflation rate to almost 4% per year, the level advocated by economists like Olivier Blanchard and Paul Krugman.

In summary, the specific optimal rate of inflation implied by the model remains very sensitive to one’s beliefs about the frequency and duration of ZLB episodes, values for which history provides only limited guidance. Given the uncertainty associated with measuring historical frequencies and durations of ZLB episodes, the wide range of plausible outcomes that can be reached for the optimal inflation rate implies that profound humility is called for by anyone advocating a specific inflation target.