Finance and Economics Discussion Series (FEDS)
April 2025
Monetary Policy Strategy and the Anchoring of Long-Run Inflation Expectations
Abstract:
Since the 1990s, monetary policy research has highlighted the properties of policy rules that stabilize inflation and economic activity, the role of inflation targeting in anchoring expectations, and the constraints posed by the effective lower bound (ELB). This paper combines these themes by examining whether explicitly responding to long-run inflation expectations improves policy effectiveness. Using both a small model for intuition and a large-scale policy model for quantitative evaluation, the analysis shows that the proposed approach reinforces inflation anchoring, reduces volatility from slow-moving inflationary forces, and mitigates ELB risks. The findings suggest that policy rules incorporating long-run inflation expectations enhance stability and complement makeup strategies by addressing ELB risks through different channels. Given that central banks already emphasize inflation expectations in their communications, this strategy aligns naturally with existing policy discussions.
Keywords: Monetary policy; inflation targeting; anchored inflation expectations; effective lower bound
DOI: https://doi.org/10.17016/FEDS.2025.027
PDF: Full Paper
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