Careful price level targeting

Abstract

This paper examines a class of interest rate rules that respond to public expectations and to lagged variables. Varying levels of commitment correspond to varying degrees of response to lagged output and targeting of the price level. If the response rises (unintentionally) above the optimal level, the outcome deteriorates severely. Hence, the optimal level of commitment is sensitive to the method of expectations formation and partial commitment is the robust, optimal policy. Keywords: Learning, Monetary Policy, Interest Rate Rules, Commitment, Price Level Targeting JEL classification: E52, E31, D84