PRICE-LEVEL TARGETING – A VIABLE ALTERNATIVE TO INFLATION TARGETING?

Abstract

The recent financial crisis that has led some central banks reaching the zero lower bound of their interest rate to use unconventional monetary policy instruments, has brought to the forefront theacademic discussions on the shift from inflation targeting (IT) to price level targeting. This paper provides a comparative analysis on IT strategy and targeting the price level, assesses the implications and highlights the challenges of an eventual transition to a new monetary policy strategy. Balancing the advantages (mainly better anchored inflation expectations) and disadvantages (communication difficulties) generated by following a potential price-level targeting strategy and the necessary prerequisites for its functionality (predictive agents, fully familiar with the implications of such a strategy and with complete confidence in themonetary authority) has led us to the conclusion that there is no common acceptance that price level targeting strategy might replace the present IT framework.

Keywords

• price-level targeting
• inflation targeting
• inflation expectations
• deflation
• zero-lower- bound