Price Level Targeting vs. Inflation Targeting:
A Free Lunch?

Lars Svensson
Institute for International Economic Studies, Stockholm University,
CEPR and NBER

First version: July 1995
This version: August 1997

Abstract


Price level targeting (without base drift) and inflation targeting (with base drift) are compared, with persistence in output (generated by sticky prices, for instance). Counter to conventional wisdom, price level targeting results in lower short-run inflation variability than inflation targeting (if output is at least moderately persistent). Price level targeting also eliminates any average inflation bias. In case society has preferences corresponding to inflation targeting, it may nevertheless prefer to assign price level targeting to the central bank. Price level targeting thus appears to have more advantages than commonly acknowledged.

Keywords: Price stability, inflation targets, rules, discretion

JEL Classification Numbers: E42, E52, E58

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