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Price‐level versus inflation targeting under model uncertainty

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  • Gino Cateau

Abstract

It has recently been suggested that price‐level targeting (PLT) may be a superior approach to monetary policy than inflation targeting (IT) due to its ability to automatically influence inflation expectations to stabilize the economy. In this paper, I analyze whether PLT dominates IT if the ability of the central bank to influence expectations is limited by model uncertainty. Specifically, I analyze how the characterization and performance of PLT and IT rules are impacted if private agents form expectations according to a model that deviates from the policy‐maker's reference model. Using robust control to derive robust rules in such a situation, I find that the performance of PLT rules deteriorate faster than that of IT rules as the degree of misspecification increases. Nevertheless, the absolute decline in performance of the PLT rules is relatively small across alternative models that are statistically plausible. Cibler le niveau des prix ou le taux d'inflation dans un contexte d'incertitude du modèle. Il a récemment été suggéré qu'une politique monétaire ciblant le niveau des prix au lieu du taux d'inflation peut mieux stabiliser l'économie de par sa plus grande capacité à influencer les attentes d'inflation. Cet article analyse dans quelle mesure un régime ciblant le niveau des prix est supérieur à un régime ciblant le taux d'inflation quand la capacité de la banque centrale à influencer les attentes d'inflation est limitée par l'incertitude du modèle. Plus précisément, j'analyse comment les paramètres et la performance des règles de politique monétaire ciblant le niveau des prix ou le taux d'inflation sont influencés quand les agents utilisent un autre modèle que celui de la banque centrale pour formuler leurs attentes. Je trouve que la performance des règles ciblant le niveau des prix se détériore plus rapidement que celle des règles ciblant le taux d'inflation à mesure que l'incertitude de modèle grandit. Néanmoins, le déclin absolu dans la performance des règles ciblant le niveau des prix est relativement faible quand les attentes des agents résultent de modèles alternatifs statistiquement plausibles.

Suggested Citation

  • Gino Cateau, 2017. "Price‐level versus inflation targeting under model uncertainty," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 50(2), pages 522-540, May.
    • Handle: RePEc:wly:canjec:v:50:y:2017:i:2:p:522-540
    DOI: 10.1111/caje.12268
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    References listed on IDEAS

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