There is a case, but there are also counter-arguments. With sufficient forward-looking behaviour among
firms and households, price-level targeting can act as a powerful built-in stabiliser through automatic shifts in
inflation expectations. This stabilisation mechanism reduces the need for large shifts in policy rates, alleviating
the risk of hitting the zero lower bound of nominal interest rates and falling into a liquidity trap. Furthermore,
credible price-level targeting can support capital accumulation by protecting the long-run purchasing power of
money and reducing the inflation risk premium embedded in actual long-term real interest rates. However,
price-level targeting can imply welfare-reducing policy-induced output volatility in situations where the degree
of forward-looking behaviour is very low. The self-regulating capacity of price-level targeting can be
undermined if central banks are not fully credible. Besides, aggressive inflation targeting can replicate some of
(but not all) the benefits of price-level targeting. On balance, the case for adopting price-level targeting is not
clear-cut, all the more so since transition costs are likely to be significant.
