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How much inflation is necessary to grease the wheels?

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  • Kim, Jinill
  • Ruge-Murcia, Francisco J.

Abstract

Tobin's proposition that inflation "greases" the wheels of the labor market is studied using a simple dynamic stochastic general equilibrium model with asymmetric wage adjustment costs. The simulated method of moments is used to estimate the nonlinear model based on its second-order approximation. Optimal inflation is determined by a benevolent government that maximizes the households' welfare. Econometric results indicate that nominal wages are downwardly rigid and that the optimal level of grease inflation for the U.S. economy is about 0.35% per year, with a 95% confidence interval ranging from 0.04% to 0.87%.

Suggested Citation

  • Kim, Jinill & Ruge-Murcia, Francisco J., 2009. "How much inflation is necessary to grease the wheels?," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 365-377, April.
  • Handle: RePEc:eee:moneco:v:56:y:2009:i:3:p:365-377
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    More about this item

    Keywords

    Optimal inflation Asymmetric adjustment costs Downward wage rigidity Nonlinear dynamics;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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