March 2, 2021, 14:00–15:30
We address this question using an estimated New Keynesian DSGE model of the Euro Area with trendinflation, imperfect indexation, and a lower bound on the nominal interest rate. In this setup, a decreasein the steady-state real interest rate,r?, increases the probability of hitting the lower bound constraint,which entails significant welfare costs and warrants an adjustment of the monetary policy strategy. Underan unchanged monetary policy rule, an increase in the inflation target of eight tenth the size of the dropin the real natural rate of interest is warranted. Absent an increase in the inflation target, and assumingthe effective lower bound prevents the ECB from implementing more aggressive negative interest ratepolicies, adjusting the monetary strategy requires considering alternative instruments or policy rules,such as committing to make-up for recent, below-target inflation realizations.