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

Abstract: The paper investigates the macroeconomics of an energy transition – a shift from brown to green energy production through carbon taxation. Using a medium-scale DSGE model with energy production sectors and  endogenous innovation in the green energy sector, we show that an energy transition – initiated through a brown energy tax – resembles a large supply side shock, causing a surge in inflation and energy prices and a decline in consumption. Innovation increases the efficiency of green energy production and drives energy prices down in the medium run. We document that monetary policy plays a critical role for the dynamics and pace of the transition, even if the transition is not explicitly part of the policy rule. A monetary policy with less emphasis on inflation stabilization allows for temporarily higher inflation and energy prices, which boosts R&D and innovation, enhancing welfare and accelerating the transition.

Abstract: We study the economic implications of a carbon tax vs. green subsidy in a heterogeneous agents New  Keynesian model with brown and green energy production and endogenous green R&D. In the short run, we find that a carbon tax results in a relatively moderate reduction in consumption, as households benefit from the redistribution of tax revenues. Conversely, a subsidy on green energy leads to a significant decline in consumption, higher taxes and higher labor demand, caused by a major shift of resources towards green R&D. All but the top 20% of the wealth distribution strongly oppose the subsidy. However, a generational conflict arises: in the long run, the subsidy leads to higher output and consumption due to increased productivity in the green energy sector, making it more beneficial for future generations.

Abstract: This paper studies the macroeconomic relevance of product size adjustment - changes in products' weight or volume - using U.K. CPI price microdata from 2012-2023: (i) Product size is relevant for 35% of the CPI. (ii) Each month, up to 0.7% of goods undergo size changes (up to 3% in the Food sector or 60% for products like chocolate). (iii) 80% of adjustments are size reductions, with 90% of them being "downgrades", i.e., raising the unit price. (iv) Size reductions and downgrades are strongly procyclical. Size increases and upgrades are acyclical. (v) Nominal price and product size adjustment are largely unrelated.

Abstract: This paper provides novel evidence from U.K. CPI microdata from 1996–2023 on the role of temporary markdowns (”sales”) for aggregate price flexibility. Sales are used as a tool to adjust regular prices: (i) Around 45% of sales occur immediately before or after a regular price increase or decrease, seemingly to divert attention from regular price hikes or to stimulate demand when regular prices are reduced. (ii) These ”strategic sales” are strongly countercyclical, while all other sales are acyclical. (iii) Sales-related regular price increases (decreases) account for 9% (11%) of all regular increases (decreases) and are 1 percentage point (0.6 percentage points) larger in absolute size. Lastly, sales-related price hikes (cuts) tend to flatten (steepen) the slope of the aggregate Phillips curve.

Abstract: Does a higher inflation target help to reduce the risk of hitting the zero lower bound (ZLB) on nominal interest rates? Recently, higher inflation targets for central banks have been proposed to allow for more "room-to-manoeuvre" in deep recessions. Advocates of this proposal suggest an inflation target of 4% to reduce the risk of hitting the ZLB. I show that the opposite may happen: a 4% inflation target can, in fact, increase the risk of hitting the ZLB compared to a 2% inflation target. Using a standard New Keynesian model, a higher inflation target changes the price-setting behavior of firms in a substantial way. Specifically, firms become more forward-looking, inflation is more volatile and, thereby, the nominal interest rate fluctuates more. I show that even with more "room-to-manoeuvre" for the nominal interest rate due to a higher inflation target, the higher volatility of the nominal interest rate implies that the economy ends up – on net – more often at the ZLB. 

Do temporary value-added tax (VAT) cuts stimulate aggregate consumption? I show that the canonical New Keynesian model predicts that they are expansionary in normal times but contractionary in deep recessions (i.e. when an effective lower bound on nominal interest rates is binding). A potential issue is that standard models only account for consumption of non-durable goods. However, in countries that levy VAT, consumer durables typically represent roughly 40% of total consumption expenditures on goods and services that are subject to the VAT. I allow for consumption of durable goods in the New Keynesian model and now find that the previous results are completely overturned: temporary consumption tax cuts have large positive macroeconomic effects both in normal times and in a liquidity trap. The reason is that purchases of durable goods are highly intertemporally substitutable - consumers will stock up on storable goods when prices are currently low. But most interestingly, I observe that the boom in the durable goods sector spills over to the non-durable goods sector. The VAT cut becomes expansionary for both non-durable and durable goods consumption. The findings of this paper suggest that it is important to distinguish between different types of consumption goods to study the aggregate effects of consumption tax changes.