R-star targeting at the effective lower bound
Ajello and al. use a small-scale New Keynesian DSGE model to construct different scenarios in order to measure the effects of policymakers’ perceptions regarding the natural rate. They use US data from 1987 through the second quarter of 2019 for core personal consumption expenditures price inflation; real GDP growth; the unemployment rate; the effective Federal Funds Rate (FFR); the long-run unemployment rate; and FFR expectations. They look at potential policy responses, one in which the central bank correctly perceives the drop in r-star as well as two possible misperceptions, in which policymakers either miss the drop, believing the rate is higher than it is, or overstate the drop to be twice as large, believing the rate is lower than it actually is. Their conclusion:
[W]hen the FFR is close to the ELB, the costs are higher if policymakers mistakenly assume that r-star is greater than its true value. This happens because the ELB limits the ability of policymakers to counter a weaker economic outlook and correct course when they realize that monetary policy is not as accommodative as was previously thought. Therefore, when the policy rate is close to the lower bound, policymakers may prefer to act under the assumption of a lower r-star.
The Asymmetric Costs of Misperceiving R-star
Authors: Andrea Ajello, Isabel Cairó, Vasco Cúrdia, and Albert Queralto
From: Federal Reserve Board, Federal Reserve Bank of San Francisco
