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What horizon for price stability

  • Smets, Frank

This paper analyses in a unified framework the twin issues of the appropriate horizon for achieving price stability in the face of unexpected disturbances and the choice of a price level versus an inflation objective. Using a small estimated forward-looking model of the euro area economy, the three main findings are: 1) The policy horizon becomes shorter the greater the weight on price stability in society's objective function, the higher the degree of 'forward-lookingness' in the economy and the greater the slope of the Phillips curve; 2) The optimal policy horizon for a price level objective is generally greater than that for an inflation objective; 3) Even if society cares about inflation stabilisation (rather than the stabilisation of the price level), it often pays to give the central bank a price level objective (rather than an inflation objective), provided the horizon is optimally chosen to be somewhat longer and there is a small weight on interest rate stabilisation in the loss function. This result depends, however, on the structure of the economy. JEL Classification: E4, E5

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Paper provided by European Central Bank in its series Working Paper Series with number 0024.

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Date of creation: Jul 2000
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Handle: RePEc:ecb:ecbwps:20000024
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  3. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
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  6. Svensson, Lars E O, 1996. "Price-level Targeting versus Inflation Targeting: A Free Lunch?," CEPR Discussion Papers 1510, C.E.P.R. Discussion Papers.
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  18. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  19. Thomas Laubach & Jeffery D. Amato, 2000. "Forecast-based monetary policy," BIS Working Papers 89, Bank for International Settlements.
  20. Nessén, Marianne, 1999. "Targeting Inflation over the Short, Medium and Long Term," Working Paper Series 98, Sveriges Riksbank (Central Bank of Sweden).
  21. Amano, Robert & Coletti, Don & Macklem, Tiff, 1999. "Monetary Rules When Economic Behaviour Changes," Working Papers 99-8, Bank of Canada.
  22. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  23. Michael T. Kiley, 1998. "Monetary policy under neoclassical and New-Keynesian Phillips Curves, with an application to price level and inflation targeting," Finance and Economics Discussion Series 1998-27, Board of Governors of the Federal Reserve System (U.S.).
  24. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
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