Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 614: Price Level Targeting vs. Inflation Targeting: A Free Lunch?

Lars E.O. Svensson ()
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Lars E.O. Svensson: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-109 61 Stockholm, Sweden

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 aknowledged.

Keywords: Price stability; inflation targets

JEL-codes: E42; E52; E58

29 pages, November 6, 1997

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