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Price-level targeting and risk management in a low-inflation economy

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  • Roberto M. Billi

Abstract

With inflation and policy interest rates at historically low levels, policymakers show great concern about "downside tail risks" due to a zero lower bound on nominal interest rates. Low probability or tail events, such as sustained deflation or recession, are disruptive for the economy and can be difficult to resolve. This paper shows that price-level targeting mitigates downside tail risks respect to inflation targeting when policy is conducted through a simple interest-rate rule subject to a zero lower bound. Thus, price-level targeting is a more effective policy framework than inflation targeting for the management of downside tail risks in a low-inflation economy. At the same time, the average performance of the economy is not very different if policy implements price-level targeting instead of inflation targeting through a simple interest-rate rule. Price-level targeting may imply less variability of inflation than inflation targeting because policymakers can shape private-sector expectations about future inflation more effectively by targeting directly the price level path rather than inflation.

Suggested Citation

  • 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.
  • Handle: RePEc:fip:fedkrw:rwp08-09
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    References listed on IDEAS

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    Cited by:

    1. Giannoni, Marc P., 2014. "Optimal interest-rate rules and inflation stabilization versus price-level stabilization," Journal of Economic Dynamics and Control, Elsevier, pages 110-129.
    2. Yuting Bai, 2014. "Price level targeting with strategic fiscal policy and the value of fiscal leadership," Working Papers 66983487, Lancaster University Management School, Economics Department.
    3. Giannoni, Marc P., 2014. "Optimal interest-rate rules and inflation stabilization versus price-level stabilization," Journal of Economic Dynamics and Control, Elsevier, pages 110-129.

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