Price-Level Targeting and Risk Management in a Low-Inflation Economy

Federal Reserve Bank of Kansas City Working Paper No. 08-09

27 Pages Posted: 31 Jan 2009  

Roberto M. Billi

Sveriges Riksbank

Date Written: December 1, 2008

Abstract

With inflation and policy interest rates at historically low levels, policymakers show great concern about "downside tail risks" due to a zero lower bound on nominal interest rates. Low probability or tail events, such as sustained deflation or recession, are disruptive for the economy and can be difficult to resolve. This paper shows that price-level targeting mitigates downside tail risks respect to inflation targeting when policy is conducted through a simple interest-rate rule subject to a zero lower bound. Thus, price-level targeting is a more effective policy framework than inflation targeting for the management of downside tail risks in a low-inflation economy. At the same time, the average performance of the economy is not very different if policy implements price-level targeting instead of inflation targeting through a simple interest-rate rule. Price-level targeting may imply less variability of inflation than inflation targeting because policymakers can shape private-sector expectations about future inflation more effectively by targeting directly the price level path rather than inflation.

Keywords: kurtosis, liquidity trap, long-run tradeoffs, monetary policy design, nonlinear, simple optimal rules, skewness, long-run stationary distribution

JEL Classification: C63, E31, E52

Suggested Citation

Billi, Roberto M., Price-Level Targeting and Risk Management in a Low-Inflation Economy (December 1, 2008). Federal Reserve Bank of Kansas City Working Paper No. 08-09. Available at SSRN: https://ssrn.com/abstract=1335299 or http://dx.doi.org/10.2139/ssrn.1335299

Roberto M. Billi (Contact Author)

Sveriges Riksbank ( email )

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

HOME PAGE: http://www.rmbilli.com

Paper statistics

Downloads
44
Abstract Views
320