The Optimal Inflation Rate in New Keynesian Models

64 Pages Posted: 3 Aug 2010

See all articles by Olivier Coibion

Olivier Coibion

University of Texas at Austin

Yuriy Gorodnichenko

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

Johannes F. Wieland

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: 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.

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

JEL Classification: E3, E4, E5

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: https://ssrn.com/abstract=1623777 or http://dx.doi.org/10.2139/ssrn.1623777

Olivier Coibion (Contact Author)

University of Texas at Austin ( email )

2317 Speedway
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

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Johannes F. Wieland

affiliation not provided to SSRN ( email )

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