Price-Level Versus Inflation Targeting with Financial Market Imperfections

31 Pages Posted: 19 Oct 2010

See all articles by Francisco Covas

Francisco Covas

Board of Governors of the Federal Reserve System

Yahong Zhang

affiliation not provided to SSRN

Abstract

Price-level targeting (PT) is compared with inflation targeting (IT) in a DSGE model augmented with imperfections in both debt and equity markets. The PT regime outperforms the IT regime, and the gain depends on the degree of financial market frictions. This is because inflation is better anchored under PT, owing to the expectation channel, and therefore the monetary authority has more leverage to deal with the financial market distortions. We also find that the gain is higher if the optimal rule reacts to asset prices instead of the output gap, and the rule requires a positive response to asset prices.

On compare le ciblage du niveau des prix (Np) au ciblage du taux d'inflation (Ti) dans un modèle d'équilibre général dynamique stochastique quand il y a imperfections dans les marchés de la dette et des actions. Le régime Np fait beaucoup mieux que le régime Ti, et l'écart dépend du degré de frictions dans les marchés financiers. La raison en est que l'inflation est mieux ancrée dans le régime Np, à cause du canal des anticipations. L'autorité monétaire a donc une plus grande capacitéà s'occuper des distorsions sur les marchés financiers. On découvre aussi que le gain est plus élevé si la règle optimale réagit aux prix des actifs plutôt qu'à l'écart entre production actuelle et production potentielle, et si la règle requiert une réponse positive aux prix des actifs.

Suggested Citation

Covas, Francisco and Zhang, Yahong, Price-Level Versus Inflation Targeting with Financial Market Imperfections. Canadian Journal of Economics/Revue Canadienne d'Economique, Vol. 43, Issue 4, pp. 1302-1332, November/Novembre 2010. Available at SSRN: https://ssrn.com/abstract=1694234 or http://dx.doi.org/10.1111/j.1540-5982.2010.01615.x

Francisco Covas

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Yahong Zhang

affiliation not provided to SSRN

No Address Available

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