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Price level versus inflation rate targets in an open economy with overlapping wage contracts

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  • Eric Hansen

Abstract

The standard result in models of sticky prices is that an inflation rate target is better than a price level target at minimizing the variance of real output. This paper provides a contradictory result: a price level target may be preferred in an economy that is characterized by flexible prices in one sector and sticky prices in another sector. An example is a highly open economy that has flexible prices in the tradeable goods sector and sticky prices (due to Taylor-type overlapping wage contracts) in the non-tradeable goods sector. The robustness of these results is confirmed for variants of the model where wage contracts are based on relative real wages (following Fuhrer/Moore (1995) and when monetary policy has a one-period implementation lag relative to wage setters. The paper discusses the implications of the result in the light of New Zealand's current monetary policy framework.

Suggested Citation

  • Eric Hansen, 1996. "Price level versus inflation rate targets in an open economy with overlapping wage contracts," Pacific Basin Working Paper Series 96-01, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfpb:96-01
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    Cited by:

    1. Laurence Ball, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
    2. Warwick McKibbin, 1997. "Which Monetary-policy Regime for Australia?," RBA Annual Conference Volume (Discontinued), in: Philip Lowe (ed.),Monetary Policy and Inflation Targeting, Reserve Bank of Australia.
    3. Eric Ghysels & Norman R. Swanson & Myles Callan, 2002. "Monetary Policy Rules with Model and Data Uncertainty," Southern Economic Journal, John Wiley & Sons, vol. 69(2), pages 239-265, October.

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    Keywords

    Inflation (Finance); Prices;

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