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Price Level Targeting in a Small Open Economy with Financial Frictions: Welfare Analysis

Ali Dib, Caterina Mendicino () and Yahong Zhang ()

Staff Working Papers from Bank of Canada

Abstract: How important are the benefits of low price-level uncertainty? This paper explores the desirability of price-level path targeting in an estimated DSGE model fit to Canadian data. The policy implications are based on social welfare evaluations. Compared to the historical inflation targeting rule, an optimal price level targeting regime substantially reduces the welfare cost of business cycle fluctuations in terms of steady state consumption. The optimal price-level targeting rule performs also better than the optimal inflation targeting rule in minimizing the distortion generated by the presence of nominal debt contracts. The occurrence of financial shocks, which are among the main sources of business cycle fluctuations in the model, significantly contributes to quantify the welfare gains of price level targeting.

Keywords: Financial stability; Inflation and prices; Monetary policy framework (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2008
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:08-40

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