The optimal inflation rate revisited
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.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jesús Fernández-Villaverde & Juan F. Rubio-Ramírez, 2007.
"How Structural Are Structural Parameters?,"
NBER Working Papers
13166, National Bureau of Economic Research, Inc.
- Du Caju, Philip & Gautier, Erwan & Momferatou, Daphne & Ward-Warmedinger, Melanie E., 2008.
"Institutional Features of Wage Bargaining in 23 European Countries, the US and Japan,"
IZA Discussion Papers
3867, Institute for the Study of Labor (IZA).
- 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.
- Du Caju, Ph. & Gautier, E. & Momferatou, D. & Ward-Warmedinger, M., 2008. "Institutional features of wage bargaining in 23 European countries, the US and Japan," Working papers 228, Banque de France.
- Du Caju, Philip & Gautier, Erwan & Momferatou, Daphne & Ward-Warmedinger, Melanie, 2008. "Institutional features of wage bargaining in 23 European countries, the US and Japan," Working Paper Series 0974, European Central Bank.
- Philip Ducaju & Erwan Gautier & Daphné Momferatou & Mélanie Ward-Warmedinge, 2008. "Institutional features of wage bargaining in 23 European countries, the US and Japan," Working Paper Research 154, National Bank of Belgium.
- 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.
When requesting a correction, please mention this item's handle: RePEc:ter:wpaper:0069. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Giovanni Di Bartolomeo)
If references are entirely missing, you can add them using this form.