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Hyperbolic Discounting and Positive Optimal Inflation

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  • Graham, Liam

    ()
    (University College London)

  • Snower, Dennis J.

    ()
    (Kiel Institute for the World Economy)

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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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 5694.

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Length: 49 pages
Date of creation: May 2011
Date of revision:
Handle: RePEc:iza:izadps:dp5694

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

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References

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  1. Andrew Caplin & John Leahy, 2001. "The social discount rate," Discussion Paper / Institute for Empirical Macroeconomics 137, Federal Reserve Bank of Minneapolis.
  2. Liam Graham & Dennis J. Snower, 2008. "Hyperbolic Discounting and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 40(2-3), pages 427-448, 03.
  3. Huang, Kevin X. D. & Liu, Zheng, 2002. "Staggered price-setting, staggered wage-setting, and business cycle persistence," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 405-433, March.
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Cited by:
  1. Guido Ascari & Argia M. Sbordone, 2013. "The Macroeconomics of Trend Inflation," DEM Working Papers Series 053, University of Pavia, Department of Economics and Management.
  2. Ahrens, Steffen & Snower, Dennis J., 2012. "Envy, Guilt, and the Phillips Curve," IZA Discussion Papers 6302, Institute for the Study of Labor (IZA).

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