Price and Output Stability Under Price Level Targeting
University of Alabama, Economics, Finance and Legal Studies Working Paper No. 01-05-01
26 Pages Posted: 8 Jun 2001
Date Written: May 2001
It is commonly believed that a monetary policy that targets the price level reduces the long-term variability of the price level but only at the cost of increased variability in both inflation and output. This paper shows that this result may not hold so long as increases in the real rate of interest cause decreases in aggregate demand. In particular it is shown that the one-step-ahead variance of output and inflation are lower under price-level targeting than under inflation targeting. Further, it is shown that the variance of inflation about its target value can be lower under price-level targeting than under inflation targeting. This increased stability under price level targeting works through an interest rate channel not previously identified in the literature on price-level and inflation targeting.
Keywords: price level targeting, inflation targeting, price stability, output stability, monetary policy
JEL Classification: E3, E4, E5
Suggested Citation: Suggested Citation