Article ID: | iaor20106971 |
Volume: | 43 |
Issue: | 4 |
Start Page Number: | 1302 |
End Page Number: | 1332 |
Publication Date: | Nov 2010 |
Journal: | Canadian Journal of Economics/Revue canadienne d'conomique |
Authors: | Covas Francisco, Zhang Yahong |
Abstract Price-level targeting (PT) is compared with inflation targeting (IT) in a DSGE model augmented with imperfections in both debt and equity markets. The PT regime outperforms the IT regime, and the gain depends on the degree of financial market frictions. This is because inflation is better anchored under PT, owing to the expectation channel, and therefore the monetary authority has more leverage to deal with the financial market distortions. We also find that the gain is higher if the optimal rule reacts to asset prices instead of the output gap, and the rule requires a positive response to asset prices.