Evaluating effectiveness of price level targeting in the presence of increasing uncertainty

Engin Kara and Ahmed Pirzada

Bristol Economics Discussion Papers from School of Economics, University of Bristol, UK

Abstract: We argue that understanding the macroeconomic effects of increasing economic uncertainty requires understanding nominal rigidities. In the standard new Keynesian model where all firms face the same degree of nominal rigidity, heightened uncertainty leads to higher inflation and lower output. Introducing heterogeneity in price stickiness, suggested by micro-evidence on prices, changes this prediction of the model. In the new model, increased uncertainty leads to decrease in both inflation and output. These effects are more pronounced with higher trend inflation. We find that price-level targeting is more effective in dealing with the consequences of increasing uncertainty than inflation targeting.

Date: 2021-01-07
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:bri:uobdis:21/737

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