Price-level versus inflation targeting with financial market imperfections

Price-level versus inflation targeting with financial market imperfections

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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: ,
Abstract:

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.

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