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Hyperbolic Discounting and Positive Optimal Inflation

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  • Graham, Liam
  • Snower, Dennis J.

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8390.

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Date of creation: May 2011
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Handle: RePEc:cpr:ceprdp:8390

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Keywords: inflation targeting; monetary policy; nominal inertia; optimal monetary policy; Phillips curve; unemployment;

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Cited by:
  1. Steffen Ahrens, Dennis Snower, 2012. "Envy, Guilt, and the Phillips Curve," Kiel Working Papers 1754, Kiel Institute for the World Economy.
  2. Guido Ascari & Argia M. Sbordone, 2013. "The macroeconomics of trend inflation," Staff Reports 628, Federal Reserve Bank of New York.

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