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What do New-Keynesian Phillips Curves imply for price level targeting?

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  • Robert Dittmar
  • William T. Gavin

Abstract

This paper extends the analysis of price level targeting to a model including the New-Keynesian Phillips Curve. We examine the inflation-output variability tradeoffs implied by optimal inflation and price level rules. In previous work with the Neoclassical Phillips Curve, we found that the choice between inflation targeting and price level targeting depended on the amount of persistence in the output gap. That is, if the output gap was not too persistent, or if lagged output did not enter the aggregate supply function, then inflation targets were preferred to price level targets. When we start with a New Keynesian Phillips Curve, the amount of persistence in the output gap still affects the relative placement of the inflation-output variability tradeoff. But, contrary to the Neoclassical case, even where the persistence of the output gap in the aggregate supply function is small or nonexistent, the price level targeting regime still results in a more favorable tradeoff between output and inflation variability than does an inflation-targeting regime.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1999-021.

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Date of creation: 1999
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Publication status: Published in Federal Reserve Bank of St. Louis Review, March/April 2000, 82(2), pp. 21-30
Handle: RePEc:fip:fedlwp:1999-021

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Keywords: Phillips curve ; Monetary policy ; Inflation (Finance);

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  1. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  2. Gray, Jo Anna & Spencer, David E, 1990. "Price Prediction Errors and Real Activity: A Reassessment," Economic Inquiry, Western Economic Association International, vol. 28(4), pages 658-81, October.
  3. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  4. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
  5. Svensson, L-E-O, 1996. "Price Level Targeting vs Inflation Targeting : A free Lunch?," Papers 614, Stockholm - International Economic Studies.
  6. Cecchetti, Stephen G & McConnell, Margaret M & Perez-Quiros, Gabriel, 2002. "Policymakers' Revealed Preferences and the Output-Inflation Variability Trade-Off: Implications for the European System of Central Banks," Manchester School, University of Manchester, vol. 70(4), pages 596-618, Special I.
  7. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  8. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  10. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.).
  11. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  12. Michael T. Kiley, 1998. "Monetary policy under neoclassical and New-Keynesian Phillips Curves, with an application to price level and inflation targeting," Finance and Economics Discussion Series 1998-27, Board of Governors of the Federal Reserve System (U.S.).
  13. Robert G. King & Mark W. Watson, 1994. "The post-war U.S. Phillips curve: a revisionist econometric history," Working Paper Series, Macroeconomic Issues 94-14, Federal Reserve Bank of Chicago.
  14. Robert Dittmar & William T. Gavin & Finn Kydland, 1999. "The inflation-output variability tradeoff and price-level targets," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 23-32.
  15. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  16. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
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