How Should Monetary Policy be Conducted in an Era of Price Stability?
1999 (English)Report (Other academic)
The paper discusses several issues related to how monetary policy should be conducted in an era of price stability. Low inflation (with base drift in the price level) and price-level stability (without such base drift) are compared, and a suitable loss function (corrseponding to flexible inflation targeting) is discussed, including the index and level for the inflation target. Three ways of maintaining price stability are examined, namely (1) a commitment to a simple instrument rule, (2) "forecast targeting," and (3) monetary targeting. Both (1) and (3) are found to be inferior to forecast targeting. The benefits of credibility (private inflatoin expectations coinciding with the inflation target) are discussed. Credibility improves the tradeoff between inflation variability, output-gap variability and instrument variability and makes it easier for the central bank to meet its inflation target. The threat of deflation and a liquidity trap is examined. Transparent inflation targeting and a contingency plan with emergency measures, including a coordinated fiscal and monetary expansion, are likely to avoid a liquidity trap, but also contribute to escaping from one if already trapped.
Place, publisher, year, edition, pages
Stockholm: IIES , 1999. , 59 p.
Seminar Paper / Institute for International Economic Studies, Stockholm University, ISSN 0347-8769 ; 680
Credibility, deflation, inflation target, liquidity trap, price-level targeting
IdentifiersURN: urn:nbn:se:su:diva-41148OAI: oai:DiVA.org:su-41148DiVA: diva2:328517