Using Conventional Monetary Policy Unconventionally: Overturning Inflation and Output Gap Dynamics Using a Super- Inertial Interest Rate Rule
Using simulations on different macroeconomic models, we show that monetary policy can mitigate the drop in output after a negative demand shock and lead to a positive inflation gap and convergence to its target from above. Thus, the risk hitting the ELB is lower due to the overshooting inflation. Such dynamics are feasible under a super-inertial rule, i.e., when the degree of interest rate smoothing is above a threshold greater than one. The more backward-looking the economy is, the higher the threshold is. Hence, a super-inertial policy should be in the toolbox of central banks to support demand-shock dominated crisis.
JEL classification: E58, E61
Keywords: Interest rate smoothing, overshooting inflation, super-inertial policy, monetary policy design, conventional and unconventional monetary policy