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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
Date of revision:
Handle: RePEc:ecb:ecbwps:20000024
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  1. Robert Amano & Don Coletti & Tiff Macklem, 1999. "Monetary Rules When Economic Behaviour Changes," Cahiers de recherche CREFE / CREFE Working Papers 81, CREFE, Université du Québec à Montréal.
  2. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
  3. Berg, C. & Jonung, L., 1998. "Pioneering Price Level Targeting: The Swedish Experience 1931-1937," Papers 642, Stockholm - International Economic Studies.
  4. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  5. David Reifschneider & John C. Williams, 2000. "Three lessons for monetary policy in a low-inflation era," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 936-978.
  6. Svensson, Lars E O, 1999. "Price-Level Targeting versus Inflation Targeting: A Free Lunch?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 277-95, August.
  7. David E. Lebow & John M. Roberts & David J. Stockton, 1992. "Economic performance under price stability," Working Paper Series / Economic Activity Section 125, Board of Governors of the Federal Reserve System (U.S.).
  8. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  9. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
  10. Svensson, Lars, 1999. "How Should Monetary Policy Be Conducted in an Era of Price Stability," Seminar Papers 680, Stockholm University, Institute for International Economic Studies.
  11. Bennett T. McCallum & Edward Nelson, . "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," GSIA Working Papers 1997-71, Carnegie Mellon University, Tepper School of Business.
  12. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September.
  13. 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.).
  14. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  15. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
  16. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  17. Alexander L. Wolman, 1999. "Real Implications of the Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 1999 1152, Society for Computational Economics.
  18. Orphanides, Athanasios & Wieland, Volker, 1999. "Inflation zone targeting," Working Paper Series 0008, European Central Bank.
  19. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  20. Jordi Gali & Mark Gertler, 2000. "Inflation Dynamics: A Structural Econometric Analysis," NBER Working Papers 7551, National Bureau of Economic Research, Inc.
  21. Thomas Laubach & Jeffery D. Amato, 2000. "Forecast-based monetary policy," BIS Working Papers 89, Bank for International Settlements.
  22. Nessén, Marianne, 1999. "Targeting Inflation over the Short, Medium and Long Term," Working Paper Series 98, Sveriges Riksbank (Central Bank of Sweden).
  23. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
  24. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
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