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Hyperbolic Discounting and Positive Optimal Inflation

Author

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  • Liam Graham
  • Dennis Snower

Abstract

The Friedman rule states that steady-state welfare is maximized when there is deflation at the real rate of interest. Recent work by Khan et al (2003) uses a richer model but still finds deflation optimal. In an otherwise standard new Keynesian model we show that, if households have hyperbolic discounting, small positive rates of inflation can be optimal. In our baseline calibration, the optimal rate of inflation is 2.1% and remains positive across a wide range of calibrations.

Suggested Citation

  • Liam Graham & Dennis Snower, 2011. "Hyperbolic Discounting and Positive Optimal Inflation," CESifo Working Paper Series 3464, CESifo.
    • Handle: RePEc:ces:ceswps:_3464
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    References listed on IDEAS

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    More about this item

    Keywords

    optimal monetary policy; inflation targeting; unemployment; Phillips curve; nominal inertia; monetary policy;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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