How Should Monetary Policy Be Conducted in an Era of Price Stability

Lars Svensson

No 680, Seminar Papers from Stockholm University, Institute for International Economic Studies

Abstract: The paper discusses several issues related to how monetary policy should be conducted in an era of price stability. Low inflation (with base drift in the price level) and price-level stability (wihtout such base drift) are compared, and a suitable loss function (corresponding to flexible inflation targeting) is discussed, including the index and level for the inflation target. Three ways of maintaining price stability are examined, namely (1) a commitment to a simple instrument rule, (2) "forecast targeting" and (3) monetary targeting. Both (1) and (3) are found to be inferior to forecast targeting. The benefits of credibility (private inflation expectations coinciding with the inflation target) are discussed. Credibility improves the tradeoff between inflation variability, output gap variability and instrument variability and makes it easier for the central bank to meet its inflation target. The threat of inflation and a liquidity trap are examined. Transparent inflation targeting and a contingency plan with emergency measures, including a coordinated fiscal and monetary expansion, are likely to avoid a liquidity trap, but also contribute to escaping from one if already trapped.

Keywords: credibility; deflation; inflation target; liquidity trap; price-level targeting (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Pages: 59 pages
Date: 1999-10-01
New Economics Papers: this item is included in nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (102)

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Related works:
Working Paper: How Should Monetary Policy be Conducted in an Era of Price Stability? (2000)
Journal Article: How should monetary policy be conducted in an era of price stability? (1999)
Working Paper: How Should Monetary Policy Be Conducted In An Era Of Price Stability? (1999)
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:iiessp:0680

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