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The Inflation-Targeting Debate$
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Ben S. Bernanke and Michael Woodford

Print publication date: 2005

Print ISBN-13: 9780226044712

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226044736.001.0001

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Inflation Targeting, Price-Path Targeting, and Output Variability

Inflation Targeting, Price-Path Targeting, and Output Variability

Chapter:
(p.173) 4 Inflation Targeting, Price-Path Targeting, and Output Variability
Source:
The Inflation-Targeting Debate
Author(s):

Stephen G. Cecchetti

Junhan Kim

Publisher:
University of Chicago Press
DOI:10.7208/chicago/9780226044736.003.0005

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

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