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This paper examines the implications for monetary policy of sticky prices in both final and intermediate goods in a New Keynesian model. Both optimal policy under commitment and discretionary policy under simple loss functions are...
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This paper examines the implications for monetary policy of sticky prices in both final and intermediate goods in a New Keynesian model. Both optimal policy under commitment and discretionary policy under simple loss functions are studied. Household utility losses under alternative loss functions are compared; additionally, the robustness of policy performance to model and shock misperceptions and parameter uncertainty is examined. Targeting inflation in both consumer and intermediate goods performs better than targeting inflation in one sector; targeting price levels of both final and intermediate goods performs significantly better. Moreover, targeting price levels in both sectors yields superior robustness properties.
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This paper draws attention to the fact that the price level in Canada-which is an inflation targeter-has strayed little from the path it would have taken had inflation never wandered off the 2% target since its introduction and ha...
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This paper draws attention to the fact that the price level in Canada-which is an inflation targeter-has strayed little from the path it would have taken had inflation never wandered off the 2% target since its introduction and has tended to revert to that path after temporary deviations. Econometric analysis using Bayesian estimation suggests that a low probability can be assigned to explaining this behavior by mutually offsetting shocks. More plausible is the assumption that inflation expectations and interest rates are determined in a way that is consistent with an element of price-level-path targeting.
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The Fed kept interest rates low and essentially unchanged during the late 1990s despite a booming economy and record-low unemployment. These interest rates were accommodative by historical standards. Nonetheless, inflation remaine...
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The Fed kept interest rates low and essentially unchanged during the late 1990s despite a booming economy and record-low unemployment. These interest rates were accommodative by historical standards. Nonetheless, inflation remained low. How did the Fed succeed in sustaining rapid economic growth without fueling inflation and inflationary expectations? In retrospect, it is evident that the productive capacity of the economy increased. Yet as events unfolded, there was uncertainty about the expansion of the capacity of the economy and therefore about the sustainability of the Fed's policy. This paper provides an explanation for the success of the Fed in accommodating growth with stable inflation in the late 1990s. It shows that if the central bank is committed to reverse policy errors it makes because of unwarranted optimism, inflation can remain in check even if the central bank keeps interest rates low because of this optimism. In particular, a price level target—which is a simple way to model a commitment to offset errors—can serve to anchor inflation even if the public does not share the central bank's optimism about shifts in potential output. The paper shows that price level targeting is superior to inflation targeting in a wide range of situations. The paper also provides econometric evidence that, in contrast to earlier periods, the Fed has recently put substantial weight on the price level in setting interest rates. Moreover, it shows that CPI announcement surprises lead to reversion in the price level. Finally, it provides textual evidence that Alan Greenspan puts relatively more weight on the price level than inflation.
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Price level targeting has been proposed as an alternative to inflation targeting that may confer benefits if a central bank sets policy under discretion, even if society's loss function is specified in terms of inflation (instead ...
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Price level targeting has been proposed as an alternative to inflation targeting that may confer benefits if a central bank sets policy under discretion, even if society's loss function is specified in terms of inflation (instead of price level) volatility. This paper demonstrates the sensitivity of this argument. If even a small portion of agents use a rule-of-thumb to form inflation expectations, or does not fully understand the nature of the target, price level targeting may in fact impose costs on society rather than benefits.
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A weight-conservative central banker setting policy with discretion and stabilizing the real exchange-rate-adjusted (REX) price level and the output gap can replicate the behavior of the rate of REX inflation and the output gap un...
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A weight-conservative central banker setting policy with discretion and stabilizing the real exchange-rate-adjusted (REX) price level and the output gap can replicate the behavior of the rate of REX inflation and the output gap under policy from a timeless perspective.
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We survey literature comparing inflation targeting (IT) and price-level targeting (PT) as macroeconomic stabilisation policies. Our focus is on New Keynesian models and areas that have seen significant developments since Ambler's ...
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We survey literature comparing inflation targeting (IT) and price-level targeting (PT) as macroeconomic stabilisation policies. Our focus is on New Keynesian models and areas that have seen significant developments since Ambler's (2009, Price-level targeting and stabilisation policy: a survey. Journal of Economic Surveys 23(5): 974-997) survey: optimal monetary policy; the zero lower bound; financial frictions and transition costs of adopting a PT regime. Ambler's conclusion that PT improves social welfare in New Keynesian models is fairly robust, but we note an interesting split in the literature: PT consistently outperforms IT in models where policymakers commit to simple Taylor-type rules, but results in favour of PT when policymakers minimise loss functions are overturned with small deviations from the baseline model. Since the beneficial effects of PT appear to hang on the joint assumption that agents are rational and the economy New Keynesian, we discuss survey and experimental evidence on rational expectations and the applied macro literature on the empirical performance of New Keynesian models. Overall, the evidence is not clear-cut, but we note that New Keynesian models can pass formal statistical tests against macro data and that models with rational expectations outperform those with behavioural expectations (i.e. heuristics) in direct statistical tests. We therefore argue that policymakers should continue to pay attention to PT.
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This paper examines the effectiveness of central bank forward guidance under inflation and price level targeting monetary policies. The results show that the beneficial effects of forward guidance increase if a central bank pursue...
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This paper examines the effectiveness of central bank forward guidance under inflation and price level targeting monetary policies. The results show that the beneficial effects of forward guidance increase if a central bank pursues price-level targeting instead of inflation targeting. Output and inflation respond more favorably to forward guidance with price-level targeting than inflation targeting. A monetary policy rule that aggressively reacts to inflation and includes interest rate inertia narrows the performance gap between the two policy regimes. However, forward guidance with price-level targeting is still preferred to forward guidance with inflation targeting after performing multiple robustness checks.
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Both price level targeting and speed limit policies have been suggested as alternatives to inflation targeting that may confer benefits when a central bank operates under discretion, even if society's loss function is specified in...
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Both price level targeting and speed limit policies have been suggested as alternatives to inflation targeting that may confer benefits when a central bank operates under discretion, even if society's loss function is specified in terms of inflation volatility. Here we show that price level targeting dominates a speed limit policy under perfect credibility and rational expectations. However, a speed limit policy is more robust than a price level target. Even for small deviations from either rationalexpectations or perfect credibility, a speed limit policy dominates a price level target.
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There is a great deal of support for nominal income targeting in the literature on strategies for monetary policy in a closed economy framework. Is nominal income targeting equally attractive in a small open economy? This paper co...
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There is a great deal of support for nominal income targeting in the literature on strategies for monetary policy in a closed economy framework. Is nominal income targeting equally attractive in a small open economy? This paper compares nominal income targeting to alternative monetary policy rules in a stochastic macro model for a small open economy. We find that both the weighting in the overall price level of the exchange rate and foreign prices and the elasticity of output supplied with respect to the real exchange rate are important factors in assessing the attractiveness of nominal income targeting. In a small open economy where the size of both parameters is not negligible, a rule targeting the overall price level may actually be preferred to nominal income targeting.
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