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The inflation-output variability tradeoff and price-level targets

  • Robert Dittmar
  • William T. Gavin
  • Finn E. Kydland

In this article, the authors describe a popular monetary policy framework based on a neoclassical Phillips Curve model. Here, the choice between an inflation target and a price-level target depends on characteristics of real output. If the output gap is relatively persistent, then targeting the price level results in a better set of policy options for the central bank. The authors present evidence from the G-10 countries showing that conventionally measured output gaps are highly persistent. The policy implication of assuming rational expectations and this Phillips Curve model is that central banks should set objectives for a price level, not an inflation rate.

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Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (1999)
Issue (Month): Jan ()
Pages: 23-32

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Handle: RePEc:fip:fedlrv:y:1999:i:jan:p:23-32:n:1
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  1. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
  2. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
  3. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  4. Svensson, L.E.O., 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," Papers 595, Stockholm - International Economic Studies.
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