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Is time ripe for price level path stability?

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  • Smets, Frank
  • Vestin, David
  • Gaspar, Ví­tor

Abstract

In the paper, we provide a critical and selective survey of arguments relevant for the assessment of the case for price level path stability (PLPS). Using a standard hybrid new Keynesian model we argue that price level stability provides a natural framework for monetary policy under commitment. There are two main arguments in favour of a PLPS regime. First, it helps overall macroeconomic stability by making expectations operate like automatic stabilizers. Second, under a price level path stability regime, changes in the price level operate like an intertemporal adjustment mechanism, reducing the magnitude of required changes in nominal interest rates. Such a property is particularly relevant as a means to alleviate the importance of the zero bound on nominal interest rates. We also review and discuss the arguments against price level path stability. Finally, we also found, using the Smets and Wouters (2003) model which includes a wide variety of frictions and is estimated for the euro area, that the price level is stationary under optimal policy under commitment. The results obtain when the quasi-difference of inflation is used in the loss function, as in the hybrid new Keynesian model. Overall, the arguments in favour of or against price level path stability depend on the degree of dependence of private sector expectations on the characteristics of the monetary policy regime. JEL Classification: E52, D83

Suggested Citation

  • Smets, Frank & Vestin, David & Gaspar, Ví­tor, 2007. "Is time ripe for price level path stability?," Working Paper Series 818, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:2007818
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    References listed on IDEAS

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    Cited by:

    1. Kenneth N. Kuttner & Adam S. Posen, 2011. "How Flexible Can Inflation Targeting Be and Still Work?," Working Paper Series WP11-15, Peterson Institute for International Economics.
    2. repec:eee:jmacro:v:55:y:2018:i:c:p:146-161 is not listed on IDEAS
    3. Iulian Vasile Popescu, 2012. "Price-Level Targeting – A Viable Alternative To Inflation Targeting?," CES Working Papers, Centre for European Studies, Alexandru Ioan Cuza University, vol. 4(4), pages 809-823, December.
    4. Hatcher, Michael, 2014. "Indexed versus nominal government debt under inflation and price-level targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 126-145.
    5. Carbone, Jared C. & Gazzale, Robert S., 2017. "A shared sense of responsibility: Money versus effort contributions in the voluntary provision of public goods," Journal of Economic Behavior & Organization, Elsevier, vol. 139(C), pages 74-87.
    6. Seppo Honkapohja & Kaushik Mitra, 2015. "Comparing Inflation and Price-Level Targeting: The Role of Forward Guidance and Transparency," Manchester School, University of Manchester, vol. 83, pages 27-59, December.
    7. Jiri Bohm & Jan Filacek, 2012. "Price-Level Targeting–A Real Alternative to Inflation Targeting?," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 62(1), pages 2-26, February.
    8. Hatcher, Michael C., 2011. "Comparing inflation and price-level targeting: A comprehensive review of the literature," Cardiff Economics Working Papers E2011/22, Cardiff University, Cardiff Business School, Economics Section.
    9. Richard C.K. Burdekin & Kris James Mitchener & Marc D. Weidenmier, 2012. "Irving Fisher and Price‐Level Targeting in Austria: Was Silver the Answer?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(4), pages 733-750, June.
    10. Cole, Stephen J., 2018. "The effectiveness of central bank forward guidance under inflation and price-level targeting," Journal of Macroeconomics, Elsevier, vol. 55(C), pages 146-161.
    11. Andreas Beyer & Vitor Gaspar & Christina Gerberding & Otmar Issing, 2008. "Opting Out of the Great Inflation: German Monetary Policy After the Break Down of Bretton Woods," NBER Working Papers 14596, National Bureau of Economic Research, Inc.
    12. Sofía Bauducco B. & Rodrigo Caputo G, 2011. "Metas de Nivel de Precios y Metas de Inflación: Una Revisión de la Literatura," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 14(1), pages 55-67, April.
    13. Meh, Césaire A. & Ríos-Rull, José-Víctor & Terajima, Yaz, 2010. "Aggregate and welfare effects of redistribution of wealth under inflation and price-level targeting," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 637-652, September.
    14. Roberto M. Billi, 2008. "Price-level targeting and risk management in a low-inflation economy," Research Working Paper RWP 08-09, Federal Reserve Bank of Kansas City.
    15. Dib, Ali & Mendicino, Caterina & Zhang, Yahong, 2013. "Price-level targeting rules and financial shocks: The case of Canada," Economic Modelling, Elsevier, vol. 30(C), pages 941-953.
    16. William T. Gavin & Benjamin D. Keen & Michael R. Pakko, 2012. "Taylor-type rules and total factor productivity," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 41-64.
    17. Giannoni, Marc P., 2014. "Optimal interest-rate rules and inflation stabilization versus price-level stabilization," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 110-129.
    18. Loisel, Olivier, 2008. "Central bank reputation in a forward-looking model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3718-3742, November.
    19. Gomes, S. & Jacquinot, P. & Mestre, R. & Sousa, J., 2015. "Global policy at the zero lower bound in a large-scale DSGE model," Journal of International Money and Finance, Elsevier, vol. 50(C), pages 134-153.
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    21. Gino Cateau, 2009. "Optimal Policy under Commitment and Price Level Stationarity," Staff Working Papers 09-8, Bank of Canada.
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    23. William T. Gavin & Benjamin D. Keen & Michael R. Pakko, 2009. "Taylor-type rules and permanent shifts in productivity growth," Working Papers 2009-049, Federal Reserve Bank of St. Louis.

    More about this item

    Keywords

    Adaptive Learning.; expectations; Price Level Stability;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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