Inflation Inertia and the Optimal Hybrid Inflation/Price-Level Target

A hybrid inflation/price-level target combines elements of both inflation and price-level targets. The paper derives an optimal hybrid target within a New Keynesian model with inflation persistence due to price indexation. The result generalizes a result by Vestin (forthcoming) that the optimal policy could be implemented with a price-level targeting regime. We show that the optimal price-level drift in the hybrid target is equal to the degree of price indexation. If there is complete indexation, the optimal monetary regime is inflation targeting.