The inflation-output variability tradeoff and price-level targets

Dittmar, Robert; Gavin, William T.; Kydland, Finn E.

Journal Article

The inflation-output variability tradeoff and price-level targets

Abstract: In this article, the authors describe a popular monetary policy framework based on a neoclassical Phillips Curve model. Here, the choice between an inflation target and a price-level target depends on characteristics of real output. If the output gap is relatively persistent, then targeting the price level results in a better set of policy options for the central bank. The authors present evidence from the G-10 countries showing that conventionally measured output gaps are highly persistent. The policy implication of assuming rational expectations and this Phillips Curve model is that central banks should set objectives for a price level, not an inflation rate.

Keywords: Inflation (Finance); Monetary policy; Phillips curve;