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Price-level versus inflation targeting with financial market imperfections

Francisco Covas () and Yahong Zhang ()

Canadian Journal of Economics, 2010, vol. 43, issue 4, 1302-1332

Abstract: Price-level targeting (PT) is compared with inflation targeting (IT) in a DSGE model augmented with imperfections in both debt and equity markets. The PT regime outperforms the IT regime, and the gain depends on the degree of financial market frictions. This is because inflation is better anchored under PT, owing to the expectation channel, and therefore the monetary authority has more leverage to deal with the financial market distortions. We also find that the gain is higher if the optimal rule reacts to asset prices instead of the output gap, and the rule requires a positive response to asset prices.

JEL-codes: E31 E44 E52 (search for similar items in EconPapers)
Date: 2010
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