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Price and Output Stability under Price‐Level Targeting

James Cover and Paul Pecorino ()

Southern Economic Journal, 2005, vol. 72, issue 1, 152-166

Abstract: It is commonly believed that a monetary policy that targets the price level reduces the long‐term variability of the price level, but only at the cost of increased variability of both inflation and output. We develop a model in which the one‐step‐ahead variance of output and the price level are lower under price‐level targeting than under inflation targeting. This increased stability under price‐level targeting works through an interest‐rate channel that, to our knowledge, has not previously been emphasized in the literature. Surprisingly, if the sensitivity of demand to the real rate of interest is high enough, then the variance of inflation can also be lower under price‐level targeting than under inflation targeting.

Date: 2005
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Handle: RePEc:wly:soecon:v:72:y:2005:i:1:p:152-166