How Should Monetary Policy be Conducted in an Era of Price Stability?

Lars Svensson

No 7516, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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 (corresponding 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 in maintaining price stability. The benefits of credibility (private inflation 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.

JEL-codes: E42 E52 (search for similar items in EconPapers)
Date: 2000-02
New Economics Papers: this item is included in nep-mon
Note: PE
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Citations: View citations in EconPapers (69)

Published as Lars E.O. Svensson, 1999. "How should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 195-259.

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Journal Article: How should monetary policy be conducted in an era of price stability? (1999)
Working Paper: How Should Monetary Policy Be Conducted In An Era Of Price Stability? (1999)
Working Paper: How Should Monetary Policy Be Conducted in an Era of Price Stability (1999)
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