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The optimal inflation rate revisited

Author

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  • Di Bartolomeo Giovanni
  • Tirelli Patrizio
  • Acocella Nicola

Abstract

We challenge the widely held belief that New Keynesian models cannot predict an optimal positive inflation rate. In fact we find that even for the US economy, characterized by relatively small government size, optimal trend inflation is justified by the Phelps argument that the inflation tax should be part of an optimal (distortionary) taxation scheme. This mainly happens because, unlike standard calibrations of public expenditures that focus on public consumption-to-GDP ratios, we also consider the diverse, highly distortionary effect of public transfers to households. Our prediction of the optimal inflation rate is broadly consistent with recent estimates of the Fed inflation target. We also contradict the view that the Ramsey-optimal policy should minimize inflation volatility over the business cycle and induce near-random walk dynamics of public debt in the long run. In fact optimal fiscal and monetary policies should stabilize long-run debt-to-GDP ratios in order to limit tax (and inflation) distortions in steady state. This latter result is strikingly similar to policy analyses in the aftermath of the 2008 financial crisis.

Suggested Citation

  • Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2011. "The optimal inflation rate revisited," wp.comunite 0069, Department of Communication, University of Teramo.
  • Handle: RePEc:ter:wpaper:0069
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    References listed on IDEAS

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    1. Jordi Galí & Pau Rabanal, 2005. "Technology Shocks and Aggregate Fluctuations: How Well Does the Real Business Cycle Model Fit Postwar U.S. Data?," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 225-318 National Bureau of Economic Research, Inc.
    2. Philip Du Caju & Erwan Gautier & Daphne Momferatu & Melanie Ward-Warmedinger, 2009. "Institutional Features of Wage Bargaining in 23 European Countries, the US and Japan," Ekonomia, Cyprus Economic Society and University of Cyprus, vol. 12(2), pages 57-108, Winter.
    3. Jesús Fernández-Villaverde & Juan F. Rubio-Ramírez, 2008. "How Structural Are Structural Parameters?," NBER Chapters,in: NBER Macroeconomics Annual 2007, Volume 22, pages 83-137 National Bureau of Economic Research, Inc.
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    Cited by:

    1. Acocella, Nicola & Di Bartolomeo, Giovanni & Tirelli, Patrizio, 2015. "U.S. Trend Inflation Reinterpreted: The Role Of Fiscal Policies And Time-Varying Nominal Rigidities," Macroeconomic Dynamics, Cambridge University Press, vol. 19(06), pages 1294-1308, September.
    2. Nicola Acocella, "undated". "Teoria e pratica della politica economica: l’eredità del recente passato," Working Papers 104/13, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.
    3. Samuel Gil Martín, 2012. "Liquidity, Welfare and Distribution," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 59(2), pages 217-234, May.
    4. Alberto Bagnai, 2013. "Unhappy families are all alike: Minskyan cycles, Kaldorian growth, and the Eurozone peripheral crises," a/ Working Papers Series 1301, Italian Association for the Study of Economic Asymmetries, Rome (Italy).
    5. Nicola Acocella, "undated". "A tale of two cities: exit policies in Washington and Frankfurt," Working Papers 117/13, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.

    More about this item

    Keywords

    Trend inflation; monetary and fiscal policy; Ramsey plan;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • J51 - Labor and Demographic Economics - - Labor-Management Relations, Trade Unions, and Collective Bargaining - - - Trade Unions: Objectives, Structure, and Effects
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity

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