The Taming of the Skew: Asymmetric Inflation Risk and Monetary

Abstract

Inflation risk in U.S. data varies considerably over time and has often been asymmetric. A model incorporating time-varying asymmetric risk achieves better forecasting accuracy than a state-of-the-art symmetric model, providing results comparable to the performance of professional forecasters. The optimal monetary strategy calls for the Central Bank to counterbalance shifts in the direction of inflation risk by adjusting its inflation target – a strategy we term risk-adjusted inflation targeting (RAIT). By adjusting the modal inflation scenario, the Central Bank can realign average inflation with its desired long-run inflation objective and effectively anchor the private sector’s expectations.