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Stabilization policy, rational expectations and price-level versus inflation targeting: a survey

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We survey recent literature comparing inflation targeting (IT) and price-level targeting (PT) as macroeconomic stabilization policies. Our focus is on New Keynesian models and areas which have seen significant developments since Ambler’s (2009) survey: the zero lower bound on nominal interest rates,financial frictions,and optimal monetary policy. Ambler’s main conclusion that PT improves the inflation-output volatility trade-off in New Keynesian models is reasonably robust to these extensions, several of which are attempts to address issues raised by the recent financial crisis. The beneficial effects of PT therefore appear to hang on the joint assumption that agents are rational and the economy New Keynesian. Accordingly, we discuss recent experimental and survey evidence on whether expectations are rational, as well as the applied macro literature on the empirical performance of New Keynesian models. In addition, we discuss a more recent strand of applied literature that has formally tested New Keynesian models with rational expectations. Overall the evidence is not conclusive, but we note that New Keynesian models are able to match a number of dynamic features in the data and that behavioural models of the macroeconomy are outperformed by those with rational expectations in formal statistical tests. Accordingly, we argue that policymakers should continue to pay attention to PT.

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  • Hatcher, Michael C. & Minford, Patrick, 2013. "Stabilization policy, rational expectations and price-level versus inflation targeting: a survey," Cardiff Economics Working Papers E2013/14, Cardiff University, Cardiff Business School, Economics Section.
  • Handle: RePEc:cdf:wpaper:2013/14
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    Cited by:

    1. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2016. "Monetarism rides again? US monetary policy in a world of Quantitative Easing," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 44(C), pages 85-102.
    2. Contessi, Silvio & Li, Li & De Pace, Pierangelo, 2014. "An international perspective on the recent behavior of inflation," Review, Federal Reserve Bank of St. Louis, vol. 96(3), pages 267-294.
    3. repec:nbb:ecrart:y:2017:m:september:i:ii:p:69-86 is not listed on IDEAS
    4. Honkapohja, Seppo & Kaushik, Mitra, 2018. "Price level targeting with evolving credibility," Research Discussion Papers 5/2018, Bank of Finland.
    5. Benchimol, Jonathan & Bounader, Lahcen, 2018. "Optimal Monetary Policy Under Bounded Rationality," Globalization and Monetary Policy Institute Working Paper 336, Federal Reserve Bank of Dallas.

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    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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