The optimal inflation rate revisited
AbstractWe challenge the widely held belief that New Keynesian models cannot predict an optimal positive inflation rate. In fact we find that even for the US economy, characterized by relatively small government size, optimal trend inflation is justified by the Phelps argument that the inflation tax should be part of an optimal (distortionary) taxation scheme. This mainly happens because, unlike standard calibrations of public expenditures that focus on public consumption-to-GDP ratios, we also consider the diverse, highly distortionary effect of public transfers to households. Our prediction of the optimal inflation rate is broadly consistent with recent estimates of the Fed inflation target. We also contradict the view that the Ramsey-optimal policy should minimize inflation volatility over the business cycle and induce near-random walk dynamics of public debt in the long run. In fact optimal fiscal and monetary policies should stabilize long-run debt-to-GDP ratios in order to limit tax (and inflation) distortions in steady state. This latter result is strikingly similar to policy analyses in the aftermath of the 2008 financial crisis.
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Trend inflation; monetary and fiscal policy; Ramsey plan;
Other versions of this item:
- Giovanni Di Bartolomeo & Patrizio Tirelli & Nicola Acocella, 2011. "The optimal inflation rate revisited," Working Papers 208, University of Milano-Bicocca, Department of Economics, revised Mar 2011.
- Giovanni Di Bartolomeo & Patrizio Tirelli & Nicola Acocella, . "The optimal inflation rate revisited," Working Papers 76/10, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- J51 - Labor and Demographic Economics - - Labor-Management Relations, Trade Unions, and Collective Bargaining - - - Trade Unions: Objectives, Structure, and Effects
- E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-03-26 (All new papers)
- NEP-CBA-2011-03-26 (Central Banking)
- NEP-DGE-2011-03-26 (Dynamic General Equilibrium)
- NEP-MAC-2011-03-26 (Macroeconomics)
- NEP-MON-2011-03-26 (Monetary Economics)
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