Average inflation targeting and the interest rate lower bound

Under conventional inflation targeting (IT), the lower bound on nominal interest rates gives rise to a systematic downward bias in that substantially reduces welfare. Using two variants of New Keynesian model, we investigate whether monetary policy strategy aims stabilize an average rate—rather than period-by-period rate—leads better outcomes. With rational expectations, price level (PLT)—the limiting case (AIT)—is optimal, yet AIT with sufficient history dependence reaps most benefits PLT. boundedly PLT is no longer optimal unless degree bounded rationality small. When deviations from expectations are sufficiently large, outcomes can be worse under or strong IT. Finally, for both conservatism improves welfare by eliminating deflationary without invoking dependence.