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The Optimal Rate of Inflation

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  • Stephanie Schmitt-Grohe
  • Martin Uribe

Abstract

Observed inflation targets around the industrial world are concentrated at two percent per year. This chapter investigates the extent to which the observed magnitudes of inflation targets are consistent with the optimal rate of inflation predicted by leading theories of monetary nonneutrality. We find that consistently those theories imply that the optimal rate of inflation ranges from minus the real rate of interest to numbers insignificantly above zero. Furthermore, we argue that the zero bound on nominal interest rates does not represent an impediment for setting inflation targets near or below zero.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16054.

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Date of creation: Jun 2010
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Publication status: published as “The Optimal Rate of Inflation,” (with Mart ́ın Uribe), in Handbook of Monetary Economics edited by Benjamin M. Friedman and Michael Woodford, Volume 3B, Elsevier, San Diego CA, 2011, 653-722.
Handle: RePEc:nbr:nberwo:16054

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  1. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March.
  2. Adam, Klaus & Billi, Roberto M., 2004. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Working Paper Series 0377, European Central Bank.
  3. Peter J. Klenow & Oleksiy Kryvtsov, 2007. "State-Dependent or Time-Dependent Pricing: Does It Matter for Recent U.S. Inflation?," Discussion Papers, Stanford Institute for Economic Policy Research 07-007, Stanford Institute for Economic Policy Research.
  4. Stephanie Schmitt-Grohé & Martín Uribe, 2009. "Foreign Demand for Domestic Currency and the Optimal Rate of Inflation," NBER Working Papers 15494, National Bureau of Economic Research, Inc.
  5. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, MIT Press, vol. 3(6), pages 1185-1236, December.
  6. Schmitt-Grohé, Stephanie & Uribe, Martín, 2009. "On Quality Bias and Inflation Targets," CEPR Discussion Papers 7550, C.E.P.R. Discussion Papers.
  7. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
  8. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 123(4), pages 1415-1464, November.
  9. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 37(2-3), pages 345-370, April.
  10. Nicolini, Juan Pablo, 1998. "Tax evasion and the optimal inflation tax," Journal of Development Economics, Elsevier, vol. 55(1), pages 215-232, February.
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Cited by:
  1. Henning Weber, 2011. "Optimal inflation and firms' productivity dynamics," Kiel Working Papers 1685, Kiel Institute for the World Economy.
  2. Angelo Melino, 2011. "Moving Monetary Policy Forward: Why Small Steps - and a Lower Inflation Target - Make Sense for the Bank of Canada," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 319, January.
  3. Otmar Issing, 2011. "Lessons for monetary policy: what should the consensus be?," Globalization and Monetary Policy Institute Working Paper 81, Federal Reserve Bank of Dallas.
  4. Niemann, Stefan & Pichler, Paul & Sorger, Gerhard, 2013. "Public debt, discretionary policy, and inflation persistence," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(6), pages 1097-1109.
  5. Tao Peng, 2012. "A Note on the implementation of the Pareto efficient allocation in the Lagos-Wright model," Economics Bulletin, AccessEcon, vol. 32(1), pages 27-36.
  6. Olivier Coibion & Yuriy Gorodnichenko & Johannes F. Wieland, 2010. "The Optimal Inflation Rate in New Keynesian Models," NBER Working Papers 16093, National Bureau of Economic Research, Inc.
  7. Rhee, Hyuk Jae & Turdaliev, Nurlan, 2013. "Central bank transparency: Does it matter?," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 183-197.
  8. Anderson, Gary S. & Kim, Jinill & Yun, Tack, 2010. "Using a projection method to analyze inflation bias in a micro-founded model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(9), pages 1572-1581, September.
  9. Bennett T. McCallum, 2011. "Should Central Banks Raise their Inflation Targets? Some Relevant Issues," NBER Working Papers 17005, National Bureau of Economic Research, Inc.
  10. Etienne B. Yehoue, 2012. "On Price Stability and Welfare," IMF Working Papers 12/189, International Monetary Fund.
  11. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics, Elsevier, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828 Elsevier.

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