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Optimal Trend Inflation

Listed author(s):
  • Adam, Klaus
  • Weber, Henning

We present a sticky-price model incorporating heterogeneous firms and systematic firm-level productivity trends. Aggregating the model in closed form, we show that it delivers radically different predictions for the optimal inflation rate than canonical sticky price models featuring homogenous firms: (1) the optimal steady-state inflation rate generically differs from zero and (2) inflation optimally responds to productivity disturbances. Using micro data from the US Census Bureau to estimate the inflation-relevant productivity trends at the firm level, we find that the optimal US inflation rate is positive. It was slightly above 2 percent in the year 1986, but continuously declined thereafter, reaching about 1 percent in the year 2013.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 12160.

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Date of creation: Jul 2017
Handle: RePEc:cpr:ceprdp:12160
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  1. Mark Bils, 2009. "Do Higher Prices for New Goods Reflect Quality Growth or Inflation?," The Quarterly Journal of Economics, Oxford University Press, vol. 124(2), pages 637-675.
  2. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
  3. Coad, Alex, 2010. "Investigating the exponential age distribution of firms," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 4, pages 1-30.
  4. Daniel Melser & Iqbal A. Syed, 2016. "Life Cycle Price Trends and Product Replacement: Implications for the Measurement of Inflation," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 62(3), pages 509-533, September.
  5. Alex Coad, 2010. "The Exponential Age Distribution and the Pareto Firm Size Distribution," Journal of Industry, Competition and Trade, Springer, vol. 10(3), pages 389-395, September.
  6. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
  7. Bilbiie, Florin O. & Fujiwara, Ippei & Ghironi, Fabio, 2014. "Optimal monetary policy with endogenous entry and product variety," Journal of Monetary Economics, Elsevier, vol. 64(C), pages 1-20.
  8. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
  9. Amano, Robert & Moran, Kevin & Murchison, Stephen & Rennison, Andrew, 2009. "Trend inflation, wage and price rigidities, and productivity growth," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 353-364, April.
  10. 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.
  11. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, vol. 63(2), pages 293-320, July.
  12. Lucia Foster & John Haltiwanger & Chad Syverson, 2008. "Reallocation, Firm Turnover, and Efficiency: Selection on Productivity or Profitability?," American Economic Review, American Economic Association, vol. 98(1), pages 394-425, March.
  13. Mikhail Golosov & Robert E. Lucas Jr., 2007. "Menu Costs and Phillips Curves," Journal of Political Economy, University of Chicago Press, vol. 115, pages 171-199.
  14. Thomas Sargent & Noah Williams & Tao Zha, 2006. "Shocks and Government Beliefs: The Rise and Fall of American Inflation," American Economic Review, American Economic Association, vol. 96(4), pages 1193-1224, September.
  15. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, Oxford University Press, vol. 123(4), pages 1415-1464.
  16. Ahn, SeHyoun & Kaplan, Greg & Moll, Benjamin & Winberry, Thomas & Wolf, Christian, 2017. "When Inequality Matters for Macro and Macro Matters for Inequality," CEPR Discussion Papers 12123, C.E.P.R. Discussion Papers.
  17. SeHyoun Ahn & Greg Kaplan & Benjamin Moll & Thomas Winberry & Christian Wolf, 2017. "When Inequality Matters for Macro and Macro Matters for Inequality," CESifo Working Paper Series 6581, CESifo Group Munich.
  18. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
  19. Bergin, Paul R. & Corsetti, Giancarlo, 2008. "The extensive margin and monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1222-1237, October.
  20. Stefano Eusepi & Bart Hobijn & Andrea Tambalotti, 2011. "CONDI: A Cost-of-Nominal-Distortions Index," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 53-91, July.
  21. SeHyoun Ahn & Greg Kaplan & Benjamin Moll & Thomas Winberry & Christian Wolf, 2017. "When Inequality Matters for Macro and Macro Matters for Inequality," NBER Chapters,in: NBER Macroeconomics Annual 2017, volume 32 National Bureau of Economic Research, Inc.
  22. Thomas Winberry & Benjamin Moll & Greg Kaplan, 2017. "When Inequality Matters for Macro and Macro Matters for Inequality," 2017 Meeting Papers 483, Society for Economic Dynamics.
  23. Carlsson, Mikael & Westermark, Andreas, 2016. "Labor market frictions and optimal steady-state inflation," Journal of Monetary Economics, Elsevier, vol. 78(C), pages 67-79.
  24. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March.
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