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The Optimal Rate of Inflation with Trending Relative Prices

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  • ALEXANDER L. WOLMAN

Abstract

The relative prices of different categories of consumption goods have been trending over time. Assuming they are exogenous with respect to monetary policy, these trends imply that monetary policy cannot stabilize the prices of all consumption categories. If prices are sticky, monetary policy then must trade off relative price distortions within different categories of consumption. Optimally, more weight should be placed on stabilizing goods and services prices that are less flexible. Calibrating a simple sticky price model to U.S. data, we find that slight deflation is optimal, even absent transactions frictions leading to a demand for money. Optimality of deflation derives from the fact that relative prices have been trending up for services, whose nominal prices seem to be less flexible.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 43 (2011)
Issue (Month): (03)
Pages: 355-384

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Handle: RePEc:mcb:jmoncb:v:43:y:2011:i::p:355-384

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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References

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  1. Jeremy Greenwood & Gokce Uysal, 2003. "New Goods and the Transition to a New Economy," Economie d'Avant Garde Research Reports 5, Economie d'Avant Garde.
  2. Erceg, Christopher & Levin, Andrew, 2006. "Optimal monetary policy with durable consumption goods," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1341-1359, October.
  3. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  4. Loyo, Eduardo, 2002. "Imaginary money against sticky relative prices," European Economic Review, Elsevier, vol. 46(6), pages 1073-1092, June.
  5. Charles T. Carlstrom & Timothy S. Fuerst & Fabio Ghironi, 2002. "Does it matter (for equilibrium determinacy) what price index the central bank targets?," Working Paper 0202, Federal Reserve Bank of Cleveland.
  6. Kevin X. D. Huang & Zheng Liu, 2003. "Inflation Targeting: What Inflation Rate to Target?," Emory Economics 0318, Department of Economics, Emory University (Atlanta).
  7. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  8. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
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Cited by:
  1. Henning Weber, 2011. "Optimal inflation and firms' productivity dynamics," Kiel Working Papers 1685, Kiel Institute for the World Economy.
  2. Gerberding, Christina & Gerke, Rafael & Hammermann, Felix, 2012. "Price-level targeting when there is price-level drift," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 757-768.
  3. Robert Amano & Kevin Moran & Stephen Murchison & Andrew Rennison, 2007. "Trend Inflation, Wage and Price Rigidities, and Welfare," Cahiers de recherche 0720, CIRPEE.
  4. Schmitt-Grohé, Stephanie & Uribe, Martín, 2012. "On quality bias and inflation targets," Journal of Monetary Economics, Elsevier, vol. 59(4), pages 393-400.

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