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The Cost Channel, Indeterminacy, and Price-Level versus Inflation Stabilization

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  • Schmidt Sebastian

    () (Goethe University Frankfurt)

Abstract

In a New Keynesian model with a cost channel of monetary transmission, discretionary inflation targeting may become susceptible to a multiplicity of equilibria and results in a larger stabilization bias than in the standard model. Both observations can be attributed to a reduction in the effectiveness of the traditional demand channel of monetary transmission. Based on this insight, we evaluate the desirability of an alternative monetary policy regime, price-level targeting. We find that the latter is almost immune to equilibrium indeterminacy and remains successful in stabilizing output and inflation. Due to the weak demand channel, the ability of the central bank to manage private sector expectations takes center stage. This is accomplished by price-level targeting through the introduction of history dependence, but not by inflation targeting.

Suggested Citation

  • Schmidt Sebastian, 2011. "The Cost Channel, Indeterminacy, and Price-Level versus Inflation Stabilization," The B.E. Journal of Macroeconomics, De Gruyter, vol. 11(1), pages 1-17, January.
  • Handle: RePEc:bpj:bejmac:v:11:y:2011:i:1:n:3
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    References listed on IDEAS

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    1. Oleksiy Kryvtsov & Malik Shukayev & Alexander Ueberfeldt, 2008. "Adopting Price-Level Targeting under Imperfect Credibility," Staff Working Papers 08-3, Bank of Canada.
    2. Vasco Gabriel & Paul Levine & Christopher Spencer & Bo Yang, 2008. "On the (ir)relevance of direct supply-side effects of monetary policy," School of Economics Discussion Papers 0408, School of Economics, University of Surrey.
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    Cited by:

    1. Jochen Michaelis, 2012. "Optimal Monetary Policy in a Currency Union: The Role of the Cost Channel," MAGKS Papers on Economics 201203, Philipps-Universit├Ąt Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).

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