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Price-level versus inflation targeting with financial market imperfections

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  • Francisco Covas
  • Yahong Zhang

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.

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Bibliographic Info

Article provided by Canadian Economics Association in its journal Canadian Journal of Economics.

Volume (Year): 43 (2010)
Issue (Month): 4 (November)
Pages: 1302-1332

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Handle: RePEc:cje:issued:v:43:y:2010:i:4:p:1302-1332

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References

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Citations

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Cited by:
  1. Yahong Zhang, 2011. "Financial Frictions, Financial Shocks and Labour Market Fluctuations in Canada," Discussion Papers 11-10, Bank of Canada.
  2. Shin-Ichi Nishiyama, 2011. "How Important are Financial Shocks for the Canadian Business Cycle?," TERG Discussion Papers 276, Graduate School of Economics and Management, Tohoku University.
  3. Rossana MEROLA, 2012. "Monetary policy and fiscal stimulus with the zero lower bound and financial frictions," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2012024, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  4. Sofía Bauducco B. & Rodrigo Caputo G, 2011. "Metas de Nivel de Precios y Metas de Inflación: Una Revisión de la Literatura," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 14(1), pages 55-67, April.
  5. Ali Dib, 2003. "Monetary Policy in Estimated Models of Small Open and Closed Economies," Working Papers 03-27, Bank of Canada.
  6. Jeannine Bailliu & Césaire Meh & Yahong Zhang, 2012. "Macroprudential Rules and Monetary Policy when Financial Frictions Matter," Working Papers 12-6, Bank of Canada.
  7. Mark J. Carney, 2009. "Commentary: using monetary policy to stabilize economic activity," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 297-311.
  8. Sofía Bauducco & Rodrigo Caputo, 2010. "Price Level Targeting and Inflation Targeting: a Review," Working Papers Central Bank of Chile 601, Central Bank of Chile.
  9. Hatcher, Michael C., 2011. "Comparing inflation and price-level targeting: A comprehensive review of the literature," Cardiff Economics Working Papers E2011/22, Cardiff University, Cardiff Business School, Economics Section.
  10. 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.

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