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The Optimality of a Zero Inflation Rate with Menu Costs: Australia

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  • Max Gillman

Abstract

This paper juxtaposes the policy trend towards a zero inflation rate against the theoretical standard of optimal deflation at the real interest rate. It extends an example monetary economy to include a simple form of nominal adjustment costs and calibrates the model with recent evidence on Australian money demand. There is a critical value that the calibrated parameter for menu costs must exceed in order for a zero inflation rate to be optimal. An inflation rate of –2 per cent to 0 per cent is found to be optimal. The quantitative results, of whether inflation‐adjustment costs imply a zero inflation rate policy for Australia, are tempered by the abstraction of the model and its sensitivity to parameters. Qualitatively, the paper shows the effects of changes in the adjustment cost function and in the structural parameters.

Suggested Citation

  • Max Gillman, 1998. "The Optimality of a Zero Inflation Rate with Menu Costs: Australia," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 31(3), pages 211-223, September.
  • Handle: RePEc:bla:ausecr:v:31:y:1998:i:3:p:211-223
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    File URL: https://doi.org/10.1111/1467-8462.00067
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