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Inflation Targeting versus Price-Path Targeting: Looking For Improvements

  • Stephen G. Cecchetti
  • Stefan Krause

Price stability is now the paramount objective for the vast majority of modern central bankers. Combined with changes in central bank structure, this policy framework has yielded low and stable inflation that has brought with it high and stable growth. Taking recent successes as a starting point, we look at the possibility for further improvements. Could countries benefit by shifting from inflation targeting to price-path targeting? Or, should policymakers adopt a hybrid between these two extremes? Whether the optimal rule is pure inflation targeting, pure price-path targeting, or some hybrid depends on the country’s output persistence. Our discussion in this paper focuses not only on hybrid rules, also on the horizon over which such rules should be evaluated. Specifically, we examine the equivalence between a rule with a high weight on inflation targeting that is evaluated only infrequently and one with a high weight on the price-path that is evaluated often. For each country, we are able to derive a horizon for target evaluation that would result in optimal policy. The general result is that when deviations of output from its potential are less persistent, the optimal horizon for target evaluation will be shorter.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 399.

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Date of creation: Dec 2006
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Handle: RePEc:chb:bcchwp:399
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  1. Lars E. O. Svensson, 1997. "Inflation Targeting: Some Extensions," NBER Working Papers 5962, National Bureau of Economic Research, Inc.
  2. Chadha, J.S. & Charles Nolan, 2002. "Inflation and Price Level Targeting in a New Keynesian Model," Cambridge Working Papers in Economics 0203, Faculty of Economics, University of Cambridge.
  3. Álvarez, L. & Dias, D. & Dhyne, E. & Hoffmann, J. & Jonker, N. & Le Bihan, H. & Lünnemann, P. & Rumler, F. & Veronese, G. & Vilmunen, J., 2005. "Price Setting in the Euro Area: Some Stylized Facts from Individual Consumer Price Data," Working papers 136, Banque de France.
  4. Nicoletta Batini & Anthony Yates, 2001. "Hybrid inflation and price level targeting," Bank of England working papers 135, Bank of England.
  5. Nessén, Marianne & Vestin, David, 2000. "Average Inflation Targeting," Working Paper Series 119, Sveriges Riksbank (Central Bank of Sweden).
  6. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
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