DP1510 Price-level Targeting versus Inflation Targeting: A Free Lunch?

Author(s): Lars E.O. Svensson
Publication Date: November 1996
Keyword(s): Inflation Targets, Price Stability
JEL(s): E42, E52, E58
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1510

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 acknowledged.