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Nominal Rigidities and the Optimal Rate of Inflation

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  • Torben M. Andersen

    () (Department of Economics, University of Aarhus, Denmark)

Abstract

Inflation may enhance the efficiency of the price system in the presence of nominal rigidities. For the price system to function efficiently there is a need for nominal prices to adjust both to real and nominal shocks for relative prices to disseminate the appropriate signals. Since the incentive for price setters to change prices depends not only on the costs of changing prices but also on the realized shocks, it follows that the rate of inflation may affect the incentive to change prices. The higher the rate of inflation the larger the incentive to change prices, and in the presence of real shocks requiring adjustment of relative prices this may lead to a better functioning price system. Empirical evidence supports that nominal rigidities are more prevalent at low rates of inflation. It follows that there cen be welfare costs of targeting inflation at too low a level.

Suggested Citation

  • Torben M. Andersen, "undated". "Nominal Rigidities and the Optimal Rate of Inflation," Economics Working Papers 2000-19, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:aarhec:2000-19
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    File URL: ftp://ftp.econ.au.dk/afn/wp/00/wp00_19.pdf
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    References listed on IDEAS

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    1. Bewley, Truman F., 1998. "Why not cut pay?," European Economic Review, Elsevier, vol. 42(3-5), pages 459-490, May.
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    Cited by:

    1. Luc Aucremanne & Guy Brys & Peter J Rousseeuw & Anja Struyf & Mia Hubert, 2003. "Inflation, relative prices and nominal rigidities," BIS Papers chapters,in: Bank for International Settlements (ed.), Monetary policy in a changing environment, volume 19, pages 81-105 Bank for International Settlements.

    More about this item

    Keywords

    Nominal rigidities; allocative efficiency; optimal rate of inflation;

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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