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Title: Should central banks switch from inflation to price-level targeting? : quantifying the benefits from long-term price stability
Author: Hatcher, Michael C.
ISNI:       0000 0004 2751 7659
Awarding Body: Cardiff University
Current Institution: Cardiff University
Date of Award: 2011
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Economic researchers have not yet quantified the long-term benefits of price-level targeting. Consequently, central banks are unable to conduct a full cost-benefit analysis vis-a-vis inflation targeting. The primary contribution of this thesis is to quantify these benefits within a dynamic stochastic general equilibrium framework, thereby laying the foundations for a full cost-benefit analysis. The thesis focuses on three key areas: consumption volatility social welfare and inflation risk premia on long-term nominal contracts. Conventional wisdom holds that the main benefit of price-level targeting is a reduction in long-term inflation risk. However, the current workhorse model for monetary analysis cannot be used to evaluate this benefit, because long-term inflation risk does not affect agents' welfare. This thesis therefore builds and simulates overlapping generations models in which long-term inflation risk matters for social welfare. In these models, consumers save over a long horizon for old age using indexed and nominal government bonds that offer imperfect insurance against inflation risk. Importantly, the extent of nominal indexation is chosen endogenously in response to monetary policy in order to address the Lucas critique and to allow for heterogeneities across countries and over time, three separate models are simulated in which consumers have access to different assets. Key findings are as follows. First, price-level targeting reduces long-term inflation risk substantially compared to inflation targeting, leading to an increase in social welfare and a reduction in consumption volatility. Second, price-level targeting reduces by an order of magnitude the inflation risk premium on nominal bonds. Finally, optimal indexation of government bonds is substantially lower under price-level targeting. Notably, there is considerable heterogeneity in results across model specifications. The estimated welfare gain from price-level targeting ranges from 0.01 to 0.17 per cent of aggregate consumption, and the estimated reduction in consumption risk ranges from 13 to 95 per cent.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available