What Horizon for Price Stability

42 Pages Posted: 11 Dec 2002

See all articles by Frank Smets

Frank Smets

European Central Bank (ECB); KU Leuven - Center for Economic Studies

Date Written: July 2000

Abstract

This paper analyses in a unified framework the twin issues of the appropriate horizon for achieving price stability in the face of unexpected disturbances and the choice of a price level versus an inflation objective. Using a small estimated forward-looking model of the euro area economy, the three main findings are: 1) The policy horizon becomes shorter the greater the weight on price stability in society's objective function, the higher the degree of "forward-lookingness" in the economy and the greater the slope of the Phillips curve; 2) The optimal policy horizon for a price level objective is generally greater than that for an inflation objective; 3) Even if society cares about inflation stabilisation (rather than the stabilisation of the price level), it often pays to give the central bank a price level objective (rather than an inflation objective), provided the horizon is optimally chosen to be somewhat longer and there is a small weight on interest rate stabilisation in the loss function. This result depends, however, on the structure of the economy.

Keywords: Monetary Policy, Strategy, Policy Rules, Euro Area

JEL Classification: E4, E5

Suggested Citation

Smets, Frank, What Horizon for Price Stability (July 2000). Available at SSRN: https://ssrn.com/abstract=355585

Frank Smets (Contact Author)

European Central Bank (ECB) ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany
+49 69 1344 6550 (Phone)
+49 69 1344 6575 (Fax)

KU Leuven - Center for Economic Studies ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

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