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Evaluating effectiveness of price level targeting in the presence of increasing uncertainty

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  • Engin Kara
  • Ahmed Pirzada

Abstract

We argue that understanding the macroeconomic effects of increasing economic uncertainty requires understanding nominal rigidities. In the standard new Keynesian model where all firms face the same degree of nominal rigidity, heightened uncertainty leads to higher inflation and lower output. Introducing heterogeneity in price stickiness, suggested by micro-evidence on prices, changes this prediction of the model. In the new model, increased uncertainty leads to decrease in both inflation and output. These effects are more pronounced with higher trend inflation. We find that price-level targeting is more effective in dealing with the consequences of increasing uncertainty than inflation targeting.

Suggested Citation

  • Engin Kara & Ahmed Pirzada, 2021. "Evaluating effectiveness of price level targeting in the presence of increasing uncertainty," Bristol Economics Discussion Papers 21/737, School of Economics, University of Bristol, UK.
  • Handle: RePEc:bri:uobdis:21/737
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    References listed on IDEAS

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