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Optimal monetary policy: is price-level targeting the next step?

  • Patrick Minford
  • David Peel

We examine whether inflation targeting should be regarded as optimal. Targeting inflation implies (undesirably) that price level variance tends to infinity: we produce some evidence from both a representative agent model and a long-used forecasting model that, once an endogenous indexation response is allowed for, price level targeting imposes no extra costs of macro variability, indeed gives significant gains. Copyright (c) Scottish Economic Society 2003.

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Article provided by Scottish Economic Society in its journal Scottish Journal of Political Economy.

Volume (Year): 50 (2003)
Issue (Month): 5 (November)
Pages: 650-667

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Handle: RePEc:bla:scotjp:v:50:y:2003:i:5:p:650-667
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  1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  2. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  3. Nessen, Marianne & Vestin, David, 2005. "Average Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 837-63, October.
  4. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92 National Bureau of Economic Research, Inc.
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  6. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
  7. Berg, Claes & Jonung, Lars, 1998. "Pioneering Price Level Targeting: The Swedish Experience 1931-1937," Seminar Papers 642, Stockholm University, Institute for International Economic Studies.
  8. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
  9. Bennett T. McCallum & Edward Nelson, . "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," GSIA Working Papers 1997-71, Carnegie Mellon University, Tepper School of Business.
  10. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  11. Bennett T. McCallum & Edward Nelson, 2000. "Nominal Income Targeting in an Open-Economy Optimizing Model," NBER Working Papers 6675, National Bureau of Economic Research, Inc.
  12. Svensson, Lars E O, 1996. "Price-level Targeting versus Inflation Targeting: A Free Lunch?," CEPR Discussion Papers 1510, C.E.P.R. Discussion Papers.
  13. Minford, Patrick, 1993. "Time-inconsistency, Democracy and Optimal Contingent Rules," CEPR Discussion Papers 767, C.E.P.R. Discussion Papers.
  14. Svensson, L.E.O., 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," Papers 595, Stockholm - International Economic Studies.
  15. Minford, Patrick & Webb, Bruce, 2005. "Estimating large rational expectations models by FIML--some experiments using a new algorithm with bootstrap confidence limits," Economic Modelling, Elsevier, vol. 22(1), pages 187-205, January.
  16. Andrews, M J & Minford, A P L & Riley, J, 1996. "On Comparing Macroeconomic Models Using Forecast Encompassing Tests," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 58(2), pages 279-305, May.
  17. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  18. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc.
  19. Patrick Minford & Eric Nowell & Bruce Webb, 2003. "Nominal Contracting and Monetary Targets -- Drifting into Indexation," Economic Journal, Royal Economic Society, vol. 113(484), pages 65-100, January.
  20. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
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