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Price-Level versus Inflation Targeting with Financial Market Imperfections

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  • Francisco Covas
  • Yahong Zhang

Abstract

This paper compares price-level-path targeting (PT) with inflation targeting (IT) in a sticky-price, dynamic, general equilibrium model augmented with imperfections in both the debt and equity markets. Using a Bayesian approach, we estimate this model for the Canadian economy. We show that the model with both debt and equity market imperfections fits the data better and use it to compare PT versus the estimated current IT regime. We find that in general PT outperforms the current IT regime. However, the gain is lower when financial market imperfections are taken into account.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp08-26.pdf
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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 08-26.

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Length: 42 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:bca:bocawp:08-26

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Keywords: Monetary policy framework; Inflation targets; Economic models;

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References

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  1. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 383-462 National Bureau of Economic Research, Inc.
  2. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  3. Vestin, David, 2006. "Price-level versus inflation targeting," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1361-1376, October.
  4. Covas, Francisco & Den Haan, Wouter, 2007. "The Role of Debt and Equity Finance over the Business Cycle," CEPR Discussion Papers 6145, C.E.P.R. Discussion Papers.
  5. Donald Coletti & René Lalonde & Dirk Muir, 2008. "Inflation Targeting and Price-Level-Path Targeting in the GEM: Some Open Economy Considerations," Working Papers 08-6, Bank of Canada.
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  9. Ali Dib & Caterina Mendicino & Yahong Zhang, 2008. "Price Level Targeting in a Small Open Economy with Financial Frictions: Welfare Analysis," Working Papers 08-40, Bank of Canada.
  10. Altinkilic, Oya & Hansen, Robert S, 2000. "Are There Economies of Scale in Underwriting Fees? Evidence of Rising External Financing Costs," Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 191-218.
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Citations

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Cited by:
  1. 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.
  2. Ali Dib, 2003. "Monetary Policy in Estimated Models of Small Open and Closed Economies," Working Papers 03-27, Bank of Canada.
  3. 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.
  4. Jeannine Bailliu & Césaire Meh & Yahong Zhang, 2012. "Macroprudential Rules and Monetary Policy when Financial Frictions Matter," Working Papers 12-6, Bank of Canada.
  5. 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.
  6. Merola, Rossana, 2010. "Financial frictions and the zero lower bound on interest rates: a DSGE analysis," MPRA Paper 29365, University Library of Munich, Germany.
  7. 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.
  8. 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.
  9. Sofía Bauducco & Rodrigo Caputo, 2010. "Price Level Targeting and Inflation Targeting: a Review," Working Papers Central Bank of Chile 601, Central Bank of Chile.
  10. Yahong Zhang, 2011. "Financial Frictions, Financial Shocks and Labour Market Fluctuations in Canada," Discussion Papers 11-10, Bank of Canada.

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