Must-Read: Paul De Grauwe and Yuemei Ji: Animal spirits and the optimal level of the inflation target

Must-Read: Paul De Grauwe and Yuemei Ji: Animal spirits and the optimal level of the inflation target:

Low inflation targets can cause economies to hit the zero lower bound during deflationary periods caused by even mild shocks…

In such circumstances, central banks lose their ability to stimulate the economy. This column assesses the risk of this happening using a model that endogenises self-perpetuating optimism and pessimism in the economy. Given agents’ intrinsic chronic pessimism during times of recession, central banks should raise their inflation targets to 3 or 4% to preserve their ability to stimulate the economy when needed.