Hyperbolic Discounting and Positive Optimal Inflation

48 Pages Posted: 1 Jun 2011

See all articles by Liam Graham

Liam Graham

University College London - Department of Economics

Dennis J. Snower

University of Kiel - Institute for World Economics (IfW); Institute for the Study of Labor (IZA); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

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Date Written: May 31, 2011

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: optimal monetary policy, inflation targeting, unemployment, Phillips curve, nominal inertia, monetary policy

JEL Classification: E200, E400, E500

Suggested Citation

Graham, Liam and Snower, Dennis J., Hyperbolic Discounting and Positive Optimal Inflation (May 31, 2011). CESifo Working Paper Series No. 3464. Available at SSRN: https://ssrn.com/abstract=1855897

Liam Graham

University College London - Department of Economics ( email )

Gower Street
London, WC1E 6BT
United Kingdom

Dennis J. Snower (Contact Author)

University of Kiel - Institute for World Economics (IfW) ( email )

Duesternbrooker Weg 120
D-24118 Kiel
Germany
+49+431-8814-235 (Phone)

Institute for the Study of Labor (IZA)

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

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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