Evaluating effectiveness of price level targeting in the presence of increasing uncertainty

Engin Kara, Ahmed J Pirzada

Research output: Working paperDiscussion paper

Abstract

We argue that understanding the macroeconomic effects of increasing economic uncertainty requires understanding nominal rigidities. In the standard new Keynesian model where all firms face the same degree of nominal rigidity, heightened uncertainty leads to higher inflation and lower output. Introducing heterogeneity in price stickiness, suggested by micro-evidence on prices, changes this prediction of the model. In the new model, increased uncertainty leads to decrease in both inflation and output. These effects are more pronounced with higher trend inflation. We find that price-level targeting is more effective in dealing with the consequences of increasing uncertainty than inflation targeting.
Original languageEnglish
Number of pages39
Publication statusUnpublished - 7 Jan 2021

Publication series

NameBristol Economics Discussion Papers
PublisherSchool of Economics, University of Bristol
No.21/737

Structured keywords

  • ECON Macroeconomics

Keywords

  • Uncertainty Shocks; Inflation; Trend Inflation; Multi-Calvo; New Keynesian

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