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Price-level targeting when there is price-level drift

  • Gerberding, Christina
  • Gerke, Rafael
  • Hammermann, Felix
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    Recent research has shown that optimal monetary policy may display considerable price-level drift. Proponents of price-level targeting have argued that the costs of eliminating the price-level drift may be reduced if the central bank responds flexibly by returning the price level only gradually to the target path (Gaspar et al., 2010). We revisit this argument in two variants of the New Keynesian model. We show that in a two-sector version of the model which allows for changes in relative prices across sectors, the costs of stabilisation under price-level targeting remain much higher than under inflation targeting for all policy-relevant horizons. Our conclusion is that extending the policy horizon is not a panacea to reduce the costs of eliminating pricelevel drift.

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    Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2010,23.

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    Date of creation: 2010
    Date of revision:
    Handle: RePEc:zbw:bubdp1:201023
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    1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
    2. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
    3. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
    4. 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.
    5. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
    6. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    7. Marc P. Giannoni, 2010. "Optimal Interest-Rate Rules in a Forward-Looking Model, and Inflation Stabilization versus Price-Level Stabilization," NBER Working Papers 15986, National Bureau of Economic Research, Inc.
    8. Kevin X. D. Huang & Zheng Liu, 2004. "Inflation targeting: what inflation rate to target?," Working Papers 04-6, Federal Reserve Bank of Philadelphia.
    9. Vestin, David, 2006. "Price-level versus inflation targeting," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1361-1376, October.
    10. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
    11. Steve Ambler, 2007. "Price-Level Targeting and Stabilization Policy: A Review," Discussion Papers 07-11, Bank of Canada.
    12. Alexander L. Wolman, 2008. "Nominal frictions, relative price adjustment, and the limits to monetary policy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 219-233.
    13. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    14. Erceg, Christopher & Levin, Andrew, 2006. "Optimal monetary policy with durable consumption goods," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1341-1359, October.
    15. Steve Ambler, 2009. "Price-Level Targeting And Stabilisation Policy: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 23(5), pages 974-997, December.
    16. Smets, Frank, 2000. "What horizon for price stability," Working Paper Series 0024, European Central Bank.
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