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How should monetary policy be conducted in an era of price stability?

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  • Lars E. O. Svensson

Abstract

The paper discusses several issues related to how monetary policy should be conducted in an era of price stability. Low inflation (with base drift in the price level) and price-level stability (wihtout such base drift) are compared, and a suitable loss function (corresponding to flexible inflation targeting) is discussed, including the index and level for the inflation target. Three ways of maintaining price stability are examined, namely (1) a commitment to a simple instrument rule, (2) "forecast targeting" and (3) monetary targeting. Both (1) and (3) are found to be inferior to forecast targeting. The benefits of credibility (private inflation expectations coinciding with the inflation target) are discussed. Credibility improves the tradeoff between inflation variability, output gap variability and instrument variability and makes it easier for the central bank to meet its inflation target. The threat of inflation and a liquidity trap are examined. Transparent inflation targeting and a contingency plan with emergency measures, including a coordinated fiscal and monetary expansion, are likely to avoid a liquidity trap, but also contribute to escaping from one if already trapped.
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Suggested Citation

  • Lars E. O. Svensson, 1999. "How should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 195-259.
  • Handle: RePEc:fip:fedkpr:y:1999:p:195-259
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    File URL: http://www.kansascityfed.org/publicat/sympos/1999/S99sven.pdf
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    References listed on IDEAS

    as
    1. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June.
    2. Kareken, John H & Muench, Thomas & Wallace, Neil, 1973. "Optimal Open Market Strategy: The Use of Information Variables," American Economic Review, American Economic Association, vol. 63(1), pages 156-172, March.
    3. Willem H. Buiter & Nikolaos Panigirtzoglou, 1999. "Liquidity Traps: How to Avoid Them and How to Escape Them," NBER Working Papers 7245, National Bureau of Economic Research, Inc.
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    5. Bernanke, Ben S. & Mihov, Ilian, 1997. "What does the Bundesbank target?," European Economic Review, Elsevier, vol. 41(6), pages 1025-1053, June.
    6. Laubach, T. & Posen, A.S., 1997. "Disciplined Discretion: Monetary Targeting in Germany and Switzerland," Princeton Essays in International Economics 206, International Economics Section, Departement of Economics Princeton University,.
    7. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
    8. Gert Peersman & Frank Smets, 1999. "Uncertainty and the Taylor rule in a simple model of the Euro-area economy," Proceedings, Federal Reserve Bank of San Francisco.
    9. Meltzer, Allan H, 1987. "Limits of Short-run Stabilization Policy: Presidential Address to the Western Economic Association, July 3, 1986," Economic Inquiry, Western Economic Association International, vol. 25(1), pages 1-14, January.
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    More about this item

    Keywords

    Monetary policy ; Prices;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • 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

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