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Optimal Inflation for the US Economy

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  • Roberto M. Billi

Abstract

This paper studies the optimal long-run inflation rate (OIR) in a small New Keynesian model, where the only policy instrument is a short-term nominal interest rate that may occasionally run against a zero lower bound (ZLB). The model allows for worst-case scenarios of misspecification. The analysis shows first, if the government optimally commits, the OIR is below 1 percent annually. Second, if the government re-optimizes each period, the OIR rises markedly to 17 percent. Third, if the government commits only to an inertial Taylor rule, the inflation bias is eliminated at very low cost in terms of welfare for the representative household. (JEL E12, E31, E43, E52, E58)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/mac.3.3.29
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File URL: http://www.aeaweb.org/aej/mac/data/2008-0080_data.zip
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 3 (2011)
Issue (Month): 3 (July)
Pages: 29-52

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Handle: RePEc:aea:aejmac:v:3:y:2011:i:3:p:29-52

Note: DOI: 10.1257/mac.3.3.29
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Cited by:
  1. Alexandru Ciungu, 2012. "Inflation targeting, the zero lower bound and post-crisis monetary policy," Post-Print dumas-00801712, HAL.
  2. Yuriy Gorodnichenko & Johannes Wieland & Olivier Coibion, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," 2012 Meeting Papers 70, Society for Economic Dynamics.
  3. Taisuke Nakata, 2013. "Optimal fiscal and monetary policy with occasionally binding zero bound constraints," Finance and Economics Discussion Series 2013-40, Board of Governors of the Federal Reserve System (U.S.).
  4. Billi, Roberto M., 2013. "Nominal GDP Targeting and the Zero Lower Bound: Should We Abandon Inflation Targeting?," Working Paper Series 270, Sveriges Riksbank (Central Bank of Sweden).
  5. Taisuke Nakata, 2013. "Uncertainty at the zero lower bound," Finance and Economics Discussion Series 2013-09, Board of Governors of the Federal Reserve System (U.S.).
  6. Carlsson, Mikael & Westermark, Andreas, 2012. "Labor-Market Frictions and Optimal Inflation," Working Paper Series 259, Sveriges Riksbank (Central Bank of Sweden).
  7. Howitt, Peter, 2012. "What have central bankers learned from modern macroeconomic theory?," Journal of Macroeconomics, Elsevier, vol. 34(1), pages 11-22.
  8. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2010. "The Optimal Inflation Rate in New Keynesian Models," Working Papers 91, Department of Economics, College of William and Mary.
  9. Bodenstein, Martin & Hebden, James & Nunes, Ricardo, 2012. "Imperfect credibility and the zero lower bound," Journal of Monetary Economics, Elsevier, vol. 59(2), pages 135-149.
  10. Peter Tulip, 2014. "Fiscal Policy and the Inflation Target," RBA Research Discussion Papers rdp2014-02, Reserve Bank of Australia.

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