Macroeconomic Stabilization: Fixed Exchange Rates Vs Inflation Targeting Vs Price Level Targeting
AbstractWe argue that the traditional question 'fixed vs. flexible exchange rates?' is not well-defined, because 'flexible exchange rates' does not explicitly specify any particular monetary policy. In traditional analyses, 'flexible exchange rates' was interpreted as implying a fixed money supply. But fixing the money supply (or fixing its growth rate at k%) is rarely advocated nowadays. To reflect today's policy debate, the traditional question should be replaced by the question 'fixed exchange rates vs. inflation targeting vs. price level targeting?'. We then build a simple macroeconomic model of a small open economy. The model incorporates an 'outside lag' in the effect of monetary policy on aggregate demand, so that inflation targeting and price level targeting are always imperfect. We use this model to compare the stabilization properties of three different monetary rules: a fixed exchange rate, a fixed inflation target, and a fixed price level target. We show that price level targeting is best for stabilizing output, the real exchange rate and the real interest rate, relative to their natural rates.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2460.
Date of creation: May 2000
Date of revision:
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Other versions of this item:
- Vivek H. Dehejia & Nicholas Rowe, 1999. "Macroeconomic Stabilisation: Fixed Exchange Rates vs Inflation Targeting vs Price Level Targeting," Carleton Economic Papers 99-15, Carleton University, Department of Economics, revised 22 Mar 2000.
- E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
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