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Hyperbolic Discounting and Positive Optimal Inflation

  • Graham, Liam

    ()

    (University College London)

  • Snower, Dennis J.

    ()

    (Kiel Institute for the World Economy)

The Friedman rule states that steady-state welfare is maximized when there is deflation at the real rate of interest. Recent work by Khan et al (2003) uses a richer model but still finds deflation optimal. In an otherwise standard new Keynesian model we show that, if households have hyperbolic discounting, small positive rates of inflation can be optimal. In our baseline calibration, the optimal rate of inflation is 2.1% and remains positive across a wide range of calibrations.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 5694.

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Length: 49 pages
Date of creation: May 2011
Date of revision:
Handle: RePEc:iza:izadps:dp5694
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