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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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  1. Paul Gomme, 1991. "Money and growth revisited," Discussion Paper / Institute for Empirical Macroeconomics 55, Federal Reserve Bank of Minneapolis.
  2. Smith, Jennifer C, 2000. "Nominal Wage Rigidity in the United Kingdom," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 110(462), pages C176-95, March.
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  4. Andrew Caplin & John Leahy, 2001. "The social discount rate," Discussion Paper / Institute for Empirical Macroeconomics 137, Federal Reserve Bank of Minneapolis.
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  6. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, Elsevier, vol. 46(2), pages 281-313, October.
  7. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
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  18. Hasan Bakhshi & Pablo Burriel-Llombart & Hashmat Khan & Barbara Rudolf, 2003. "Endogenous price stickiness, trend inflation, and the New Keynesian Phillips curve," Bank of England working papers 191, Bank of England.
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Cited by:
  1. Ahrens, Steffen & Snower, Dennis J., 2012. "Envy, guilt, and the Phillips curve," Economics Working Papers 2012-01, Christian-Albrechts-University of Kiel, Department of Economics.
  2. Guido Ascari & Argia M. Sbordone, 2013. "The macroeconomics of trend inflation," Staff Reports, Federal Reserve Bank of New York 628, Federal Reserve Bank of New York.

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