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The optimal inflation rate revisited

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  • Di Bartolomeo Giovanni
  • Tirelli Patrizio
  • Acocella Nicola

Abstract

We 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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Bibliographic Info

Paper provided by Department of Communication, University of Teramo in its series wp.comunite with number 0069.

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Date of creation: Mar 2011
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Handle: RePEc:ter:wpaper:0069

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Web page: http://wp.comunite.it/

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Keywords: Trend inflation; monetary and fiscal policy; Ramsey plan;

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  1. Du Caju, Philip & Gautier, Erwan & Momferatou, Daphne & Ward-Warmedinger, Melanie E., 2008. "Institutional Features of Wage Bargaining in 23 European Countries, the US and Japan," IZA Discussion Papers 3867, Institute for the Study of Labor (IZA).
  2. Jesús Fernández-Villaverde & Juan F. Rubio-Ramírez, 2007. "How Structural Are Structural Parameters?," NBER Working Papers 13166, National Bureau of Economic Research, Inc.
  3. Jordi Galí & Pau Rabanal, 2005. "Technology Shocks and Aggregate Fluctuations: How Well Does the Real Business Cycle Model Fit Postwar U.S. Data?," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 225-318 National Bureau of Economic Research, Inc.
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Cited by:
  1. Acocella Nicola, 2013. "Teoria e pratica della politica economica: l'eredità del recente passato," Rivista di storia economica, Società editrice il Mulino, Società editrice il Mulino, issue 2, pages 223-248.
  2. Alberto Bagnai, 2013. "Unhappy families are all alike: Minskyan cycles, Kaldorian growth, and the Eurozone peripheral crises," a/ Working Papers Series, Italian Association for the Study of Economic Asymmetries, Rome (Italy) 1301, Italian Association for the Study of Economic Asymmetries, Rome (Italy).
  3. Samuel Gil Martín, 2012. "Liquidity, Welfare and Distribution," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 59(2), pages 217-234, May.
  4. Nicola Acocella, . "A tale of two cities: exit policies in Washington and Frankfurt," Working Papers, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF 117/13, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.

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