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Price-Level Uncertainty, Price-Level Targeting, and Nominal Debt Contracts

Allan Crawford, Cesaire Meh and Yaz Terajima

Bank of Canada Review, 2009, vol. 2009, issue Spring, 33-43

Abstract: Many central banks around the world have embraced inflation targeting as a monetary policy framework. Interest is growing, however, in price-level targeting as an alternative. The choice of frameworks has important consequences for financial contracts, most of which are not fully indexed to the price level. Changes in the price level therefore lead to changes in the real value of contracts. Price-level targeting would reduce the size of these changes in real wealth and decrease uncertainty about the future price level. This article assesses the merits of price-level targeting vis-à-vis inflation targeting from a debt-revaluation perspective, with a focus on channels affecting risk premiums, the maturities of nominal debt contracts, and redistribution of wealth. A general conclusion flowing from the analysis is that accounting for the revaluation of nominal debts and assets strengthens the relative merits of price-level targeting compared with inflation-targeting.

Date: 2009
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Handle: RePEc:bca:bcarev:v:2009:y:2009:i:spring09:p:33-43