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Hybrid inflation and price level targeting

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Nicoletta Batini
Anthony Yates

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Abstract

The previous literature on the benefits of price level versus inflation targeting has, with some qualifications, established that price level targeting entails lower price level variance at the expense of higher inflation and output variance. This paper investigates the properties of monetary regimes that combine price level and inflation targeting. It offers two characterisations of these regimes: a set of optimal control rules obtained assuming that policy-makers minimise a loss function that penalises a mixed price level/inflation target; and a set of simple rules feeding back from alternative combinations of (current and future-dated) price level and inflation deviations from target. Asymptotic variances are derived of the price level, inflation and output associated with each of these regimes when the economy is modelled as a small-scale open-economy RE model calibrated on UK data. The conclusions are that: (i) the relative merits of price level and inflation targeting, as well as of mixes of these two, are a function of several modelling and policy assumptions; and (ii) these merits do not change monotonically in the move from one regime to another. It appears also that the probability of nominal interest rates hitting a 'zero bound' under the alternative regimes is model-specific and varies non-monotonically among them.

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Paper provided by Bank of England in its series Bank of England working papers with number 135.

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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Richard Mash, 2003. "New Keynesian Microfoundations Revisited: A Calvo-Taylor-Rule-of-Thumb Model and Optimal Monetary Policy Delegation," Economics Series Working Papers 174, University of Oxford, Department of Economics. [Downloadable!]
  2. Nicoletta Batini & Douglas Laxton, 2006. "Under What Conditions Can Inflation Targeting Be Adopted? The Experience of Emerging Markets," Working Papers Central Bank of Chile 406, Central Bank of Chile. [Downloadable!]
  3. Teruyoshi Kobayashi, 2005. "Optimal monetary policy and the role of hybrid inflation-price-level targets," Applied Economics, Taylor and Francis Journals, vol. 37(18), pages 2119-2125, October. [Downloadable!] (restricted)
  4. Richard Mash, 2002. "New Keynesian Microfundations Revisited: A Generalised Calvo-Taylor Model and the Desirability of Inflation vs. Price Level Targeting," Economics Series Working Papers 109, University of Oxford, Department of Economics. [Downloadable!]
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  5. Christopher Allsopp, 2002. "The Future of Macroeconomic Policy in the European Union," Discussion Papers 07, Monetary Policy Committee Unit, Bank of England. [Downloadable!]
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  8. Stephen G. Cecchetti & Stefan Krause, 2006. "Inflation Targeting versus Price-Path Targeting: Looking For Improvements," Working Papers Central Bank of Chile 399, Central Bank of Chile. [Downloadable!]
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  10. Alexander Mihailov, 2007. "Does Instrument Independence Matter under the Constrained Discretionof an Inflation Targeting Goal? Lessons from UK Taylor Rule Empirics," Money Macro and Finance (MMF) Research Group Conference 2006 95, Money Macro and Finance Research Group. [Downloadable!]
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  12. Eva Ortega & Nooman Rebei, 2006. "The Welfare Implications of Inflation versus Price-Level Targeting in a Two-Sector, Small Open Economy," Working Papers 06-12, Bank of Canada. [Downloadable!]
  13. Tibor Hledik, 2003. "Modelling the Second-Round Effects of Supply-Side Shocks on Inflation," Working Papers 2003/12, Czech National Bank, Research Department. [Downloadable!]
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  16. WenShwo Fang & Stephen M. Miller & Chih-Chuan Yeh, 2007. "Quantile Inferences for Inflation and Its Variability: Does a Threshold Inflation Rate Exist?," Working papers 2007-45, University of Connecticut, Department of Economics. [Downloadable!]
  17. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," NBER Working Papers 10195, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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