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The Optimal Inflation Rate with Discount Factor Heterogeneity

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  • Antoine Lepetit

Abstract

This paper shows that deviations from long-run price stability are optimal in the presence of price stickiness whenever profit and utility flows are discounted at a different rate. In that case, a monetary authority acting under commitment will choose a path for the inflation rate that ends with a non-zero value. Such a property is relevant in a wide range of macroeconomic environments. I first illustrate this by studying optimal monetary policy in a New Keynesian model with a perpetual youth structure. In this setting, profit flows are discounted more heavily than utility flows and the optimal inflation target is equal to 3.2 percent in a baseline calibration of the model. I also show that this property leads to a positive long-run inflation rate in models with firm entry and exit and in environments with search and matching frictions in the labor market and another form of nominal rigidity, wage stickiness.

Suggested Citation

  • Antoine Lepetit, 2018. "The Optimal Inflation Rate with Discount Factor Heterogeneity," Finance and Economics Discussion Series 2018-086, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2018-86
    DOI: 10.17016/FEDS.2018.086
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    File URL: https://www.federalreserve.gov/econres/feds/files/2018086pap.pdf
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    Cited by:

    1. Dennery, Charles, 2019. "Dampened expectations in the Phillips Curve: A note," Economics Letters, Elsevier, vol. 184(C).
    2. 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, revised Feb 2019.
    3. FUJIWARA Ippei & HORI Shunsuke & WAKI Yuichiro, 2019. "Generational War on Inflation: Optimal Inflation Rates for the Young and the Old," Discussion papers 19021, Research Institute of Economy, Trade and Industry (RIETI).
    4. Christopher D. Cotton, 2020. "The Inflation Target and the Equilibrium Real Rate," Working Papers 20-2, Federal Reserve Bank of Boston, revised 01 Feb 2020.
    5. Alfredo García-Hiernaux & María T. González-Pérez & David E. Guerrero, 2020. "Eurozone prices: a tale of convergence and divergence," Working Papers 2010, Banco de España;Working Papers Homepage.

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    More about this item

    Keywords

    Discount factor heterogeneity; Inflation target; Optimal inflation rate; Optimal monetary policy; Perpetual youth; Sticky prices;
    All these keywords.

    JEL classification:

    • 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
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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