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Optimal Trend Inflation

Author

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  • 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: (1) the optimal steady-state inflation rate generically differs from zero and (2) inflation optimally responds to productivity disturbances. We show this by aggregating a heterogenous-firm model with sticky prices in closed form. Using firm-level data from the U.S. Census Bureau, we estimate the historically optimal inflation path for the U.S. economy. In the year 1977, the optimal inflation rate stood at 1.5%, but subsequently declined to around 1.0% in the year 2015. Inflation rates up to twice these numbers can be rationalized if one considers product demand elasticities more in line with the trade literature or if one considers firms that (partially) index prices to lagged inflation rates.

Suggested Citation

  • Klaus Adam & Henning Weber, 2018. "Optimal Trend Inflation," CESifo Working Paper Series 7028, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_7028
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. OIKAWA Koki & UEDA Kozo, 2018. "Reallocation Effects of Monetary Policy," Discussion papers 18056, Research Institute of Economy, Trade and Industry (RIETI).
    2. Galí, Jordi, 2018. "The State of New Keynesian Economics: A Partial Assessment," CEPR Discussion Papers 13095, C.E.P.R. Discussion Papers.
    3. Jordi Galí, 2018. "The State of New Keynesian Economics: A Partial Assessment," NBER Working Papers 24845, National Bureau of Economic Research, Inc.
    4. repec:aea:jecper:v:32:y:2018:i:3:p:87-112 is not listed on IDEAS
    5. Philippe Andrade & Jordi Galí & Hervé Le Bihan & Julien Matheron, 2017. "The optimal inflation target and the natural rate of interest," Economics Working Papers 1591, Department of Economics and Business, Universitat Pompeu Fabra.
    6. Antoine Lepetit, 2017. "The Optimal Inflation Rate with Discount Factor Heterogeneity," Working Papers hal-01527816, HAL.

    More about this item

    Keywords

    optimal inflation rate; sticky prices; firm heterogeneity;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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