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The Optimal Inflation Rate under Schumpeterian Growth

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  • Koki Oikawa
  • Kozo Ueda

Abstract

In this study, we analyze the relationship between inflation and economic growth. To this end, we construct a model of endogenous growth with creative destruction, incorporating sticky prices due to menu costs. Inflation and deflation reduce the reward for innovation via menu cost payments and, thus, lower the frequency of creative destruction. Central banks can maximize the rate of economic growth by setting their target inflation rate at the negative of a fundamental growth rate that would be realized without price stickiness. The optimal inflation rate, however, may differ from the growth-maximizing inflation rate because of overinvestment in R&D and indeterminacy. Both mechanisms indicate a higher optimal inflation rate than the negative of a fundamental growth rate. Our calibrated model shows that the optimal inflation rate is close to the growth-maximizing inflation rate and that a deviation from the optimal level has sizable impacts on economic growth.

Suggested Citation

  • Koki Oikawa & Kozo Ueda, 2015. "The Optimal Inflation Rate under Schumpeterian Growth," CAMA Working Papers 2015-14, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    • Handle: RePEc:een:camaaa:2015-14
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    More about this item

    Keywords

    creative destruction; menu cost; new Keynesian; monetary policy;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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