Abstract

http://ssrn.com/abstract=1623777
 
 

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The Optimal Inflation Rate in New Keynesian Models


Olivier Coibion


University of Texas at Austin

Yuriy Gorodnichenko


University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA)

Johannes F. Wieland


affiliation not provided to SSRN

August 2, 2010


Abstract:     
We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the effects of positive steady-state inflation and show that steady-state inflation affects welfare through three distinct channels: steady-state effects, the magnitude of the coefficients in the utility-function approximation, and the dynamics of the model. We solve for the optimal level of inflation in the model and find that, for plausible calibrations, the optimal inflation rate is low, less than two percent, even after considering a variety of extensions, including price indexation, endogenous price stickiness, capital formation, model-uncertainty, and downward nominal wage rigidities. On the normative side, price level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability.

Number of Pages in PDF File: 64

Keywords: Optimal Inflation, New Keynesian, Zero Bound, Price Level Targeting

JEL Classification: E3, E4, E5

working papers series


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Date posted: August 3, 2010  

Suggested Citation

Coibion, Olivier and Gorodnichenko, Yuriy and Wieland, Johannes F., The Optimal Inflation Rate in New Keynesian Models (August 2, 2010). Available at SSRN: http://ssrn.com/abstract=1623777 or http://dx.doi.org/10.2139/ssrn.1623777

Contact Information

Olivier Coibion (Contact Author)
University of Texas at Austin ( email )
Austin, TX 78712
United States
Yuriy Gorodnichenko
University of California, Berkeley - Department of Economics ( email )
549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
HOME PAGE: http://www.econ.berkeley.edu/~ygorodni/index.htm
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Institute for the Study of Labor (IZA)
P.O. Box 7240
Bonn, D-53072
Germany
Johannes F. Wieland
affiliation not provided to SSRN ( email )
Feedback to SSRN


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