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Inflation Targeting versus Price-Path Targeting: Looking For Improvements

Stephen Cecchetti () and Stefan Krause Montalbert

Working Papers Central Bank of Chile from Central Bank of Chile

Abstract: Price stability is now the paramount objective for the vast majority of modern central bankers. Combined with changes in central bank structure, this policy framework has yielded low and stable inflation that has brought with it high and stable growth. Taking recent successes as a starting point, we look at the possibility for further improvements. Could countries benefit by shifting from inflation targeting to price-path targeting? Or, should policymakers adopt a hybrid between these two extremes? Whether the optimal rule is pure inflation targeting, pure price-path targeting, or some hybrid depends on the country’s output persistence. Our discussion in this paper focuses not only on hybrid rules, also on the horizon over which such rules should be evaluated. Specifically, we examine the equivalence between a rule with a high weight on inflation targeting that is evaluated only infrequently and one with a high weight on the price-path that is evaluated often. For each country, we are able to derive a horizon for target evaluation that would result in optimal policy. The general result is that when deviations of output from its potential are less persistent, the optimal horizon for target evaluation will be shorter.

Date: 2006-12
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