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Optimal Trend Inflation

Author

Listed:
  • Klaus Adam
  • Henning Weber

Abstract

Sticky price models featuring heterogeneous firms and systematic firm-level productivity trends deliver radically different predictions for the optimal inflation rate than their popular homogenous-firm counterparts: (i) the optimal steady-state inflation rate generically differs from zero and (ii) inflation optimally responds to productivity disturbances. We show this by aggregating a heterogeneous-firm model with sticky prices in closed form. Using firm-level data from the US Census Bureau, we estimate the historically optimal inflation path for the US economy: the optimal inflation rate ranges between 1 percent and 3 percent per year and displays a downward trend over the period 1977–2015.

Suggested Citation

  • Klaus Adam & Henning Weber, 2019. "Optimal Trend Inflation," American Economic Review, American Economic Association, vol. 109(2), pages 702-737, February.
    • Handle: RePEc:aea:aecrev:v:109:y:2019:i:2:p:702-37
    Note: DOI: 10.1257/aer.20171066
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    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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