^*Donald Coletti is a research adviser, René Lalonde is a model adviser, and Dirk Muir is a principal researcher with the Bank of Canada's International Department. We would like to thank Carlos DeResende, Wei Dong, Ippei Fujiwara, Robert Lafrance, Douglas Laxton, Warwick McKibbin, Rhys Mendes, Paolo Pesenti, Nooman Rebei, Lawrence Schembri, Yang Zhang, an anonymous referee, and participants at the Reserve Bank of New Zealand workshop on "The Interface Between Monetary Policy and Macro Modelling" held in March 2006; the IMF "Workshop on Open Economy Models for Policy Evaluation" held in April 2007; and the Reserve Bank of Australia workshop "Monetary Policy in Open Economies" held in December 2007. We owe special thanks to Stephen Murchison for his invaluable insights. We also thank Susanna Mursula, Hope Pioro, and André Poudrier for excellent research assistance.

Abstract

This paper compares the capability of simple inflation targeting (IT) and price-level-path targeting (PLPT) rules to minimize inflation and output gap variability in a two-country, two-sector version of the Global Economy Model calibrated for Canada and the United States. We find that simple PLPT rules are slightly better than simple IT rules at macroeconomic stabilization and that the presence of terms-of-trade shocks tends to bolster the case for PLPT. Lastly, we demonstrate that the choice of monetary policy framework in the United States does not affect the relative merits of IT vs. PLPT in Canada.