Working Paper: NBER ID: w16054
Authors: Stephanie Schmitt-Grohe; Martin Uribe
Abstract: Observed inflation targets around the industrial world are concentrated at two percent per year. This chapter investigates the extent to which the observed magnitudes of inflation targets are consistent with the optimal rate of inflation predicted by leading theories of monetary nonneutrality. We find that consistently those theories imply that the optimal rate of inflation ranges from minus the real rate of interest to numbers insignificantly above zero. Furthermore, we argue that the zero bound on nominal interest rates does not represent an impediment for setting inflation targets near or below zero.
Keywords: Inflation; Monetary Policy; Friedman Rule
JEL Codes: E31; E4; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| observed inflation targets (E31) | optimal rate of inflation predicted by monetary theories (O42) |
| constraints of nominal interest rates (E43) | optimal inflation policy (E31) |
| tax incompleteness and nominal rigidities (H31) | deviation from the Friedman rule (E19) |
| foreign demand for domestic currency (F31) | optimal inflation rate (E31) |