Price-Level Targeting Versus Inflation Targeting in a New Keynesian Model with Inflation Persistence

Abstract

We compare Price-Level Targeting (PLT) versus Inflation Targeting (IT) using a New Keynesian model, which exhibits inflation persistence (as a result of partial indexation to lagged inflation). We find that, for standard values of the underlying parameters, (i) the loss associated to macroeconomic volatility may decrease about 29% by switching to PLT, (ii) a wide range of values for the weight given by the PLT central bank to output stabilisation allows to attain higher levels of social welfare, (iii) the higher the price rigidity the wider the range over which PLT outperforms IT, but the lower the welfare gain, and (iv) only when the level of indexation is higher than 65% it becomes better not to switch to PLT.

JEL classification codes:

• E52
• E58

Key words:

• inflation targeting
• price-level targeting
• indexation
• macroeconomic stability