Public finance and the optimal inflation rate

Recent literature shows that the inclusion of public transfers into New Keynesian models can solve the puzzling result of optimal zero inflation, which odds with both empirical evidence and monetary authorities' targets. The effect is due to the different incentives to finance public expenditures through taxes or seigniorage deriving from transfers and public consumption. By considering a richer framework this paper investigates how commonly-used features of New Keynesian models affect the incentive to use different instruments to finance public transfers, and, therefore, optimal inflation. Specifically, we consider the impact on inflation of different degrees of real distortions in goods and labor markets, sticky monopolistic wages, and price and wage indexation. We also take account of potentially non-unitary elasticity of the demand for money with respect to consumption by introducing consumption scale effects in the monetary transactions technology.