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Optimal Trend Inflation and Monetary Policy under Trending Relative Prices

Author

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  • Toyoichiro Shirota

    (Bank of Japan)

Abstract

In the standard new Keynesian models, the optimal inflation rate is zero while the long-run inflation rate is non-zero positive in many countries. In this paper, we provide a new rationale for the non-zero trend inflation by utilizing the productivity gap between the intermediate-goods sector and the final-goods sector. The productivity gap among the sectors creates the relative price trend of the CPI and the PPI, which is observed in the actual data. Then, we show that the Ramsey-optimal inflation rate of the CPI is positive while that of the PPI is negative. In addition, the efficient allocation cannot be achieved under the productivity gap. Finally, we investigate the optimal monetary policy response to a shock under the trend inflation. Our results suggest that non-zero trend inflation dramatically alters the optimal monetary policy.

Suggested Citation

  • Toyoichiro Shirota, 2007. "Optimal Trend Inflation and Monetary Policy under Trending Relative Prices," Bank of Japan Working Paper Series 07-E-1, Bank of Japan.
    • Handle: RePEc:boj:bojwps:07-e-1
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    File URL: http://www.boj.or.jp/en/research/wps_rev/wps_2007/data/wp07e01.pdf
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    Citations

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    Cited by:

    1. Alexander L. Wolman, 2011. "The Optimal Rate of Inflation with Trending Relative Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(2‐3), pages 355-384, March.
    2. Ikeda, Daisuke, 2015. "Optimal inflation rates with the trending relative price of investment," Journal of Economic Dynamics and Control, Elsevier, vol. 56(C), pages 20-33.

    More about this item

    Keywords

    Trend inflation; CPI; PPI; Optimal monetary policy; Relative price trend; Sectoral productivity gap;
    All these keywords.

    JEL classification:

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

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