Price-level versus inflation targeting

This paper shows that price-level targeting outperforms inflation targeting in the standard New-Keynesian model, under the assumption that the central bank is forced to operate in an environment characterized by discretion. In the benchmark case, with no persistence in the shocks, the commitment solution can be fully replicated. Intuitively, price-level targeting introduces history dependence and a stationary level of prices, both of which are prominent features of the commitment solution. (c) 2006 Elsevier B.V. All rights reserved.