Abstract

In this chapter we provide a critical and selective survey of arguments relevant for the assessment of the case for price-level path stability (PLPS). Using a standard, hybrid new Keynesian model, we argue that price-level stability provides a natural framework for monetary policy under commitment. There are two main arguments in favor of a PLPS regime. First, it helps overall macroeconomic stability by making expectations operate like automatic stabilizers. Second, under a PLPS regime, changes in the price level operate like an intertemporal adjustment mechanism, reducing the magnitude of required changes in nominal interest rates. Such a property is particularly relevant as a means to alleviate the importance of the zero bound on nominal interest rates. We also review and discuss the arguments against PLPS. Finally, we also demonstrate, using the Smets and Wouters (2003) model that includes a wide variety of frictions and is estimated for the euro area, that the price level is stationary under optimal policy under commitment for a particular loss function. Specifically, the results obtained when the quasi-difference of inflation is used in the loss function, as in the hybrid new Keynesian model. Overall, the arguments in favor of or against PLPS depend upon the degree of dependence of private-sector expectations on the characteristics of the monetary policy regime.

Introduction

According to the conventional wisdom in central banking circles, PLPS is not an appropriate goal to delegate to an independent central bank. There is strong intuition behind this claim.