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Price-Level Targeting and Relative-Price Shocks

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Abstract

Stephen Murchison reviews the findings of recent Bank of Canada research on the relative merits of inflation targeting and price-level targeting (PLT) for a small open economy, such as Canada's, that is susceptible to large and persistent terms-of-trade shocks. These shocks have been identified as a potential threat to PLT, since central bankers have to induce large fluctuations in output if they are to unwind all pass-through to the price level. The balance of evidence suggests that PLT and inflation targeting, implemented through simple policy rules, are fairly similar in their ability to stabilize inflation, the output gap, and interest rates. The author shows that this conclusion is robust to the inclusion of several types of relative-price shocks, including shocks to the terms of trade. Research on the optimal price index under PLT is also discussed, and Murchison concludes that, conditional on adopting PLT, the overall CPI would represent close to an ideal index to target.

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Bibliographic Info

Article provided by Bank of Canada in its journal Bank of Canada Review.

Volume (Year): 2010 (2010)
Issue (Month): Summer ()
Pages: 11-21

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Handle: RePEc:bca:bcarev:v:2010:y:2010:i:summer10:p:11-21

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Cited by:
  1. Hatcher, Michael C. & Minford, Patrick, 2013. "Stabilization policy, rational expectations and price-level versus inflation targeting: a survey," Cardiff Economics Working Papers E2013/14, Cardiff University, Cardiff Business School, Economics Section.
  2. Iulian Vasile Popescu, 2012. "Price-Level Targeting – A Viable Alternative To Inflation Targeting?," CES Working Papers, Centre for European Studies, Alexandru Ioan Cuza University, vol. 4, pages 809-823, December.
  3. Kozicki, Sharon, 2012. "Macro has progressed," Journal of Macroeconomics, Elsevier, vol. 34(1), pages 23-28.

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