Inflation Targeting, Price-Path Targeting, and Output Variability

Stephen G. Cecchetti and Junhan Kim

in The Inflation-Targeting Debate

Published by University of Chicago Press

Published in print February 2005 | ISBN: 9780226044712
Published online February 2013 | e-ISBN: 9780226044736 | DOI:
Inflation Targeting, Price-Path Targeting, and Output Variability

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Price-path targeting, or “price-level targeting” as it is often called, implies that when the price level is above or below the target path, the objective of policy is to return it to the present target path. This means that if prices move above the target path, then policy will need to bring them back down. This chapter examines whether a country is well advised to target inflation, target the price path, or do something in between. The issue turns on the persistence of output variability from their trend. With high persistence, the theoretical results suggest that countries are best off if they adopt a hybrid target that is close to price-path targeting. The chapter considers the welfare loss from adopting pure inflation or price-path targeting rather than the optimal hybrid. It shows that price-path targeting is less risky, in that the maximum social loss from being wrong—choosing price-path targeting when something else is better—is much smaller than if one chooses inflation targeting.

Keywords: inflation targeting; price-path targeting; output variability; social loss; prices; welfare loss; inflation

Chapter.  10312 words.  Illustrated.

Subjects: Financial Markets

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