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The Optimal Inflation Rate and the Sources of Productivity Growth

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  • Weber, Henning

Abstract

We consider a sticky price economy with exogenous firm entry and exit, featuring three sources of productivity growth: (1) general TFP increases affecting all firms, (2) a learning effect causing firms to become more productive with age, and (3) a cohort effect that causes newly entering firms to expand the technology frontier. Aggregating the model with heterogeneous firms in closed form, we show that the welfare optimal steady state inflation rate is generally different from zero. The optimal inflation rate increases with the strength of the learning effect, decreases with the strength of the cohort effect and is independent of the strength of the TFP effect. In the absence of firm turnover, the optimal inflation rate jumps discontinuously and is zero at all times. To the extent that aggregate growth is increasingly driven by productivity gains of newly entering firms, the model thus suggests lower inflation rates to be optimal. We provide some empirical evidence in this regard.

Suggested Citation

  • Weber, Henning, 2016. "The Optimal Inflation Rate and the Sources of Productivity Growth," VfS Annual Conference 2016 (Augsburg): Demographic Change 145872, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc16:145872
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    Cited by:

    1. Marc Dordal-i-Carreras & Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2016. "Infrequent but Long-Lived Zero-Bound Episodes and the Optimal Rate of Inflation," NBER Working Papers 22510, National Bureau of Economic Research, Inc.
    2. Anthony M. Diercks, 2015. "The Equity Premium, Long-Run Risk, & Optimal Monetary Policy," Finance and Economics Discussion Series 2015-87, Board of Governors of the Federal Reserve System (U.S.).
    3. Anthony Diercks, 2016. "The Equity Premium, Long-Run Risk, and Optimal Monetary Policy," 2016 Meeting Papers 207, Society for Economic Dynamics.
    4. Weber, Henning, 2012. "One for all: The ECB's inflation target," Kiel Policy Brief 54, Kiel Institute for the World Economy (IfW Kiel).

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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