Monetary Policy Rules and Stability: Inflation Targeting versus Price-Level Targeting

Monetary policy rules help central banks exercise the discipline necessary to achieve their long-term goals. The type of rule many banks are turning to these days is inflation targeting, which has several advantages. But in following the rule, banks usually base their actions on forecasts of future inflation, and this can lead to inflation-rate instability in some cases. A price-level target offers many of the same benefits as an inflation target, but because it uses past inflation to guide the bank’s actions, it avoids this vulnerability.