Lukas Heim evaluates the performance of a price-level targeting rule compared to that of a
standard inflation targeting rule. The comparison is based on a medium-scale DSGE model which
has been estimated based on state-of-the-art Bayesian methods. The model for the Swiss economy
is an expanded version of the framework proposed by Galì and Monacelli (2005) as well as
Monacelli (2005). It is enriched with habit formation in consumption price indexation labor
market imperfections and several additional structural disturbances. The results show that -
exactly as expected - the volatility of inflation is quite significantly lower under the
price-level targeting regime whereas the volatility of the output gap is markedly higher
conditional on either productivity or preference shocks. Therefore the introduction of a
price-level targeting regime would likely produce an increase in the volatility of real
economic activity conditional on both supply-side and demand-side shocks. Since inflation and
output are targeted simultaneously none of the two policies is strictly dominant.
