Title
Inflation versus PriceLevel Targeting: Bayesian Estimation of a Small Open DSGE Model for Switzerland (BestMasters),Used
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Lukas Heim evaluates the performance of a pricelevel targeting rule compared to that of a standard inflation targeting rule. The comparison is based on a mediumscale DSGE model which has been estimated based on stateoftheart Bayesian methods. The model for the Swiss economy is an expanded version of the framework proposed by Gal and Monacelli (2005) as well as Monacelli (2005). It is enriched with habit formation in consumption, price indexation, labor market imperfections, and several additional structural disturbances. The results show that exactly as expected the volatility of inflation is quite significantly lower under the pricelevel targeting regime, whereas the volatility of the output gap is markedly higher conditional on either productivity or preference shocks. Therefore, the introduction of a pricelevel targeting regime would likely produce an increase in the volatility of real economic activity conditional on both supplyside and demandside shocks. Since inflation and output are targeted simultaneously, none of the two policies is strictly dominant.
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