[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Appendix: Price Level Targeting
Almost all central banks focus on inflation, not the price level, and they implement
monetary policy through their control of a nominal interest rate. Some economists
have advocated forms of price level targeting in which the central bank would try
to keep the price level constant rather than simply keep inflation low. Although this
type of price level targeting is not practiced by any central bank, many traditional
textbooks treat central banks as if their chief concern were the level of prices. The
approach we have followed—one that focuses on inflation and the policy response
to inflation—can easily be modified to deal with the case of a central bank that
targets the price level.
Under a policy of targeting the price level, the central bank will increase the
nominal interest rate whenever the price level rises and lower the nominal interest
rate whenever the price level falls. The objective in either case is to affect the real
interest rate and aggregate expenditures. Rather than leading to the negative relationship
between inflation and aggregate expenditures represented by our ADI
curve, a policy of price level targeting will lead to a negative relationship between
the price level and aggregate expenditures. This relationship, shown in Figure 38.5,
is usually called an aggregate demand curve.
PRICE LEVEL (P )
Figure 38.5
Y f
OUTPUT (Y )
THE AGGREGATE DEMAND
CURVE
AD
If the central bank adjusts the interest
rate whenever the price level deviates
from its target level, the ADI curve is
replaced with a relationship between the
price level (P) and aggregate expenditures
called the aggregate demand (AD)
curve. If P increases, the central bank
increases the interest rate, leading to a
reduction in aggregate expenditures.
Changes in fiscal policy or shocks to consumption,
investment, or net exports
shift the aggregate demand curve in the
same way they would shift the ADI curve.
An increase in government purchases, for
instance, shifts the AD curve to the right.
862 ∂ CHAPTER 38 CONTROVERSIES IN MACROECONOMIC POLICY