Finance and Economics Discussion Series (FEDS)
August 2025
Implications of Inflation Dynamics for Monetary Policy Strategies
Hess Chung, Callum Jones, Antoine Lepetit, and Fernando M. Martin
Abstract:
This paper considers robust monetary policy strategies both in situations of low demand and low inflation and when economic developments pose a tradeoff between inflation and output stabilization. We proceed in two parts. First, our quantitative analysis suggests that asymmetric average inflation targeting can provide modest benefits over other inflation-targeting strategies when the risks associated with the effective lower bound remain significant. Second, motivated by the recent experience of persistent supply shocks and rapid increases in inflation, we describe the main qualitative features of optimal policy in circumstances when the objectives of stabilizing inflation and economic activity conflict. We find that monetary policy may allow inflation to depart from the target in response to certain supply shocks or in cases when sectoral dynamics are relevant, but that it should be ready to respond forcefully and expeditiously to large inflationary shocks or if inflation expectations are at risk of becoming unanchored.
Keywords: Alternative monetary policy strategies, monetary policy communication, effective lower bound, supply shocks, sectoral dynamics, inflation surges
DOI: https://doi.org/10.17016/FEDS.2025.072
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