Working Paper: NBER ID: w21392
Authors: Guido Ascari; Louis Phaneuf; Eric Sims
Abstract: We offer a comprehensive evaluation of the welfare and cyclical implications of moderate trend inflation. In an extended version of a medium-scale New Keynesian model, recent proposals to increase trend inflation from 2 to 4 percent would generate a consumption-equivalent welfare loss of 3.7 percent based on the non-stochastic steady state and of 6.9 percent based on the stochastic mean. Welfare costs of this magnitude are driven by four main factors: i) multiperiod nominal wage contracting, ii) trend growth in investment-specific and neutral technology, iii) roundaboutness in the U.S. production structure, and iv) and the interaction between trend inflation and shocks to the marginal efficiency of investment (MEI), insofar that this type of shock is sufficiently persistent. Moreover, moderate trend inflation has important cyclical implications. It interacts much more strongly with MEI shocks than with either productivity or monetary shocks.
Keywords: trend inflation; welfare costs; business cycle; New Keynesian models
JEL Codes: E31; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trend inflation (E31) | welfare costs (I30) |
| staggered wage contracts (J31) | welfare costs (I30) |
| trend growth in technology (O49) | welfare costs (I30) |
| trend inflation (E31) | business cycle dynamics (E32) |
| trend inflation (E31) | output responses (C67) |
| trend inflation (E31) | aggregate variables (C43) |