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January/February 1999, 
Vol. 81, No. 1
Posted 1999-01-01

The Inflation-Output Variability Tradeoff and Price-Level Targets

by Robert Dittmar, William T. Gavin, and Finn E. Kydland

The authors describe a popular monetary policy framework based on a neoclassical Phillips Curve model. Here, the choice between an inflation target and a price-level target depends on characteristics of real output. If the output gap is relatively persistent, then targeting the price level results in a better set of policy options for the central bank. The authors present evidence from the G-10 countries showing that conventionally measured output gaps are highly persistent. The policy implications of assuming rational expectations and this Phillips curve model is that central banks should set objectives for a price level, not an inflation rate.