Bank for International Settlements publishes research finding inflation surprises can halt learning of new effective lower bound strategies

The Bank for International Settlements has published a working paper examining how private sector agents learn a new monetary policy strategy introduced while policy rates are at the effective lower bound. In the model, the key learning window runs from the point when rates would have neared liftoff under the old framework through the early stage of liftoff under the new rule. Recessionary shocks during that period can delay learning, while large inflationary shocks can stop it, limiting the new strategy’s ability to offset the disinflationary bias created by the effective lower bound. The paper studies an asymmetric average inflation targeting rule in a standard New Keynesian framework where the central bank does not fully reveal, or is not fully believed on, all elements of the new policy function, so agents must infer them over time. Simulations indicate that even partial learning can materially reduce the incidence of effective lower bound episodes and improve output and inflation outcomes relative to the old regime. Using the post-Covid United States as an illustration, the authors find that matching the data requires large monetary policy shocks that kept rates lower than the new rule would imply from output and inflation alone, and that those shocks also fed back into the learning process. The publication notes that the views expressed are those of the authors and do not necessarily reflect those of the BIS or its member central banks.