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Inflation Targeting versus Price-Path Targeting: Looking For Improvements

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  • Stephen G. Cecchetti
  • Stefan Krause

Abstract

Price stability is now the paramount objective for the vast majority of modern central bankers. Combined with changes in central bank structure, this policy framework has yielded low and stable inflation that has brought with it high and stable growth. Taking recent successes as a starting point, we look at the possibility for further improvements. Could countries benefit by shifting from inflation targeting to price-path targeting? Or, should policymakers adopt a hybrid between these two extremes? Whether the optimal rule is pure inflation targeting, pure price-path targeting, or some hybrid depends on the country’s output persistence. Our discussion in this paper focuses not only on hybrid rules, also on the horizon over which such rules should be evaluated. Specifically, we examine the equivalence between a rule with a high weight on inflation targeting that is evaluated only infrequently and one with a high weight on the price-path that is evaluated often. For each country, we are able to derive a horizon for target evaluation that would result in optimal policy. The general result is that when deviations of output from its potential are less persistent, the optimal horizon for target evaluation will be shorter.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 399.

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Date of creation: Dec 2006
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Handle: RePEc:chb:bcchwp:399

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  1. Chadha, J.S. & Charles Nolan, 2002. "Inflation and Price Level Targeting in a New Keynesian Model," Cambridge Working Papers in Economics 0203, Faculty of Economics, University of Cambridge.
  2. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  3. Svensson, Lars E O, 1999. " Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Wiley Blackwell, vol. 101(3), pages 337-61, September.
  4. Batini, Nicoletta & Yates, Anthony, 2003. " Hybrid Inflation and Price-Level Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(3), pages 283-300, June.
  5. Nessen, Marianne & Vestin, David, 2005. "Average Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 837-63, October.
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Cited by:
  1. Schmitt-Grohé, Stephanie & Uribe, Martín, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeonomic Model," CEPR Discussion Papers 5424, C.E.P.R. Discussion Papers.
  2. Luis F. Céspedes & Claudio Soto, 2007. "Credibility and Inflation Targeting in Chile," Central Banking, Analysis, and Economic Policies Book Series, in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 14, pages 547-578 Central Bank of Chile.
  3. Sebastian Edwards, 2006. "The Relationship Between Exchange Rates and Inflation Targeting Revisited," Working Papers Central Bank of Chile 409, Central Bank of Chile.

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