Working Paper: CEPR ID: DP8390
Authors: Liam Graham; Dennis J. Snower
Abstract: 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.
Keywords: inflation targeting; monetary policy; nominal inertia; optimal monetary policy; Phillips curve; unemployment
JEL Codes: E20; E40; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| hyperbolic discounting (D15) | optimal positive inflation rate (E31) |
| optimal positive inflation rate (E31) | employment levels (J23) |
| hyperbolic discounting (D15) | employment levels (J23) |
| inflation redistributes disutility of labor (H31) | decrease in real wages (J39) |
| decrease in real wages (J39) | higher average labor levels (J89) |
| inflation (E31) | positive trade-off with real macroeconomic activity (E44) |
| optimal inflation rate under inefficiency (E31) | positive inflation rate (E31) |