Price level targeting and risk management

The desirability of a nominal-level target during zero lower bound (ZLB) episodes has become a relevant topic for central bankers and academics. In such a context, this article studies the effects of uncertainty about the future state of the economy on the performance of strict-price-level targeting versus nominal-GDP-level targeting. These targeting frameworks are compared in a small New Keynesian model, which offers a clear illustration of the tradeoffs faced by the central bank. The analysis shows that uncertainty about the future hampers economic performance to a greater extent under nominal-GDP-level targeting, relative to strict-price-level targeting. The reason is that strict-price-level targeting induces greater policy inertia and, therefore, improves the tradeoffs faced by the central bank during ZLB episodes.