Hyperbolic Discounting and Positive Optimal Inflation
48 Pages Posted: 1 Jun 2011
Date Written: May 31, 2011
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: Suggested Citation