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The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?

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  • Olivier Coibion
  • Yuriy Gorodnichenko
  • Johannes Wieland

Abstract

We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the effects of positive steady-state inflation and solve for the optimal level of inflation in the model. For plausible calibrations with costly but infrequent episodes at the zero lower bound, the optimal inflation rate is low, typically

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  • Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
  • Handle: RePEc:oup:restud:v:79:y:2012:i:4:p:1371-1406
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