“Having looked at monetary policy from both sides now, I can testify that central banking in practice is as much art as science. Nonetheless, while practicing this dark art, I have always found the science quEite useful.” 2 Alan S. Blinder

The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB/US model to quantify the effects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these effects. During particularly severe contractions, open-market operations alone may be insufficient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero inflation rate, there is a signi cant increase in the variability of output but not inflation. However, a simple modification to the Taylor rule yields a dramatic reduction in the detrimental e ects of the zero bound.

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One decade of inflation targeting in the world offers lessons on the design and implementation of inflation targeting, the conduct of monetary policy, and country performance under inflation targeting. This paper reviews briefly the main design features of 19 inflation targeting experiences, analyzes statistically if countries under inflation targeting are structurally different from non-inflation targeting industrial countries, and reviews existing evidence about the success of inflation targeting. The interaction of inflation targeting design features and the conduct of monetary policy during transition to low inflation are tackled next. The paper ends by focusing on unresolved issues on design and implementation of inflation targeting and their relation to the conduct of monetary policy – open issues that have to be addressed in the next decade of inflation targeting.

This paper extends the analysis of price level targeting to a model including the NewKeynesian Phillips Curve. We examine the inflation-output variability tradeoffs implied by optimal inflation and price level rules. In previous work with the Neoclassical Phillips Curve, we found that the choice between inflation targeting and price level targeting depended on the amount of persistence in the output gap. That is, if the output gap was not too persistent, or if lagged output did not enter the aggregate supply function, then inflation targets were preferred to price level targets. When we start with a New Keynesian Phillips Curve, the amount of persistence in the output gap still affects the relative placement of the inflation-output variability tradeoff. But, contrary to the Neoclassical case, even where the persistence of the output gap in the aggregate supply function is small or nonexistent, the price level targeting regime still results in a more favorable tradeoff between output an...

We exploit data on historical revisions to real-time estimates of the output gap to examine the implications of measurement error for the design of monetary policy, using the Federal Reserve’s model of the U.S. economy, FRB/US. Measurement error brings about a substantial deterioration in economic performance, although the problem can be mitigated somewhat by reducing the coefficient on the output gap in policy rules. We also show that it is usually optimal to place some weight on the level of the output gap in the conduct of policy, but under extreme conditions it may be preferable to focus on output growth.

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The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada. iii Contents

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