Bernanke’s proposal of a temporary price level target can therefore be regarded as a special application of Yellen’s “makeup strategy”, where one aims to make the “makeup” mechanism specific and potentially more credible by formalising it in terms of a temporary new target definition for the central bank. Higher inflation target A proposal for which Olivier Blanchard, former chief economist at the International Monetary Fund (IMF), is one of the strongest advocates is to raise the central banks’ inflation targets. 28 The idea is straightforward. With a higher inflation target, say 3 per cent, the nominal policy rate would be on average 1 percentage point higher compared to when the inflation target is 2 per cent, assuming that the new target is credible. There would therefore be a further 1 percentage point to reduce the rate before it reaches its lower bound. An increase in the inflation target to 4 per cent would increase the scope for reducing the policy rate by another percentage point, and so on. However, some argue that raising the target is not a good idea. One fear is that higher inflation would mean that inflation would also vary more, which indeed ap-  26  See also, for instance, Evans (2012). 27 One might also therefore call this approach a temporary target for average inflation. A target for average infla-  tion is a strategy reminiscent of a price level target, but nevertheless different in certain aspects, see Nessén and Vestin (2005) or Andersson and Claussen (2017).
The effect would then be in practice the same as if the target had been lowered to 1 per cent. With a lower expected rate of inflation the nominal interest rates in the economy, including the repo rate, will on average be lower. This means that in future economic downturns the distance between the repo rate and the lower bound may be smaller than before. If the repo rate hits its lower bound earlier, and remains there for longer periods, it will be a less effective tool in counteracting economic downturns. It will be even more difficult than it is now to bring down the real interest rate as low as one might need. The essence of this is that “preventive” increases in the repo rate would ultimately not result in more ammunition, but less. It is therefore important that increases in the repo rate are not made in such a way that inflation will be tangibly lower and confidence in the inflation target is put at risk. Cut the repo rate further? Another possible means of counteracting an economic slowdown is to cut the interest rate more than to the −0.5 per cent level which has so far been the lowest point. It may be possible to go even lower − for instance, the policy rate in Switzerland is at −0.75 per cent. But personally I think the possibilities here are fairly limited.