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Price Level vs. Nominal Income Targeting: Aggregate Demand Shocks and the Cost Channel of Monetary Policy Transmission

  • Malik, Hamza

This paper incorporates both the traditional aggregate demand-interest rate channel and the cost channel of monetary policy in a baseline ‘new Keynesian’ model and study two targeting regimes --- price-level targeting and nominal income targeting. In light of empirical considerations, alternative specifications for the aggregate demand and aggregate supply side of the economy also considered. The main result is that the cost channel matters: in case of a moderate policy response and with the cost channel operating the volatility of real output decreases under both price-level and nominal income targeting, while it increases in case of an aggressive policy response. The paper also finds that nominal income targeting performs better than price level targeting in bringing down the volatility of real output in almost all the specifications of the macro models used in the analysis.

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File URL: https://mpra.ub.uni-muenchen.de/456/1/MPRA_paper_456.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 456.

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Date of creation: Mar 2005
Date of revision: Aug 2006
Handle: RePEc:pra:mprapa:456
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  24. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  25. 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.).
  26. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, December.
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  28. Robert Dittmar & William T. Gavin, 1999. "What do New-Keynesian Phillips Curves imply for price level targeting?," Working Papers 1999-021, Federal Reserve Bank of St. Louis.
  29. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
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  31. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
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