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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. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
  2. Roberto M. Billi & Klaus Adam, 2004. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2004 67, Society for Computational Economics.
  3. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  4. Schmitt-Grohé, Stephanie & Uribe, Martín, 2009. "On Quality Bias and Inflation Targets," CEPR Discussion Papers 7550, C.E.P.R. Discussion Papers.
  5. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March.
  6. Peter J. Klenow & Oleksiy Kryvtsov, 2005. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," NBER Working Papers 11043, National Bureau of Economic Research, Inc.
  7. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation stabilization and welfare: The case of a distorted steady state," Discussion Papers 0405-04, Columbia University, Department of Economics.
  8. Schmitt-Grohé, Stephanie & Uribe, Martín, 2009. "Foreign Demand for Domestic Currency and the Optimal Rate of Inflation," CEPR Discussion Papers 7549, C.E.P.R. Discussion Papers.
  9. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  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. Bennett T. McCallum, 2011. "Should central banks raise their inflation targets? Some relevant issues," Economic Quarterly, Federal Reserve Bank of Richmond, issue 2Q, pages 111-131.
  2. Paul Pichler & Gerhard Sorger & Stefan Niemann, 2011. "Public debt, discretionary policy, and inflation persistence," 2011 Meeting Papers 887, Society for Economic Dynamics.
  3. 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.
  4. 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.
  5. Gary S. Anderson & Jinill Kim & Tack Yun, 2010. "Using a projection method to analyze inflation bias in a micro-founded model," Finance and Economics Discussion Series 2010-18, Board of Governors of the Federal Reserve System (U.S.).
  6. Etienne B. Yehoue, 2012. "On Price Stability and Welfare," IMF Working Papers 12/189, International Monetary Fund.
  7. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828 Elsevier.
  8. Henning Weber, 2011. "Optimal inflation and firms' productivity dynamics," Kiel Working Papers 1685, Kiel Institute for the World Economy.
  9. 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.
  10. Rhee, Hyuk Jae & Turdaliev, Nurlan, 2013. "Central bank transparency: Does it matter?," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 183-197.
  11. 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.

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