Working Paper: NBER ID: w5719
Authors: Lars E. O. Svensson
Abstract: Price level targeting (without base drift) and inflation targeting (with base drift) are compared under commitment and discretion, with persistence in unemployment. Price level targeting is often said to imply more short-run inflation variability and thereby more employment variability than inflation targeting. Counter to this conventional wisdom, under discretion a price level target results in lower inflation variability than an inflation target (if unemployment is at least moderately persistent). A price level target also eliminates the inflation bias under discretion and, as is well known, reduces long-term price variability. Society may be better off assigning a price level target to the central bank even if its preferences correspond to inflation targeting. A price level target thus appears to have more advantages than commonly acknowledged.
Keywords: Price Level Targeting; Inflation Targeting; Monetary Policy; Economic Stability
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Price level targeting (E31) | lower inflation variability (E31) |
| Inflation targeting (E31) | higher inflation variability (E31) |
| Price level targeting eliminates inflation bias (E31) | lower overall inflation variability (E31) |
| Price level targeting incorporates implicit employment target (E31) | influences inflation response to employment changes (E31) |
| Decision rules derived from price level target (E30) | more stable inflation environment (E31) |