Optimal Inflation Target : Insights from an Agent-Based Model

Which level of inflation should Central Banks be targeting? We investigate this issue in the contextof a simplified Agent Based Model of the economy. Depending on the value of the parameters thatdescribe the behaviour of agents (in particular inflation anticipations), we find a rich variety ofbehaviour at the macro-level. Without any active monetary policy, our ABM economy can be in ahigh inflation/high output state, or in a low inflation/low output state. Hyper-inflation, deflationand "business cycles" between coexisting states are also found. We then introduce a Central Bankwith a Taylor rule-based inflation target, and study the resulting aggregate variables. Our mainresult is that too-low inflation targets are in general detrimental to a CB-monitored economy. Onesymptom is a persistent under-realisation of inflation, perhaps similar to the current macroeconomicsituation. Higher inflation targets are found to improve both unemployment and negative interestrate episodes. Our results are compared with the predictions of the standard DSGE model