The Optimal Rate of Inflation with Trending Relative Prices

FRB Richmond Working Paper No. 09-2

34 Pages Posted: 12 Dec 2012

Date Written: March 3, 2009

Abstract

The relative prices of different categories of consumption goods have been trending over time. Assuming they are exogenous with respect to monetary policy, these trends imply that monetary policy cannot stabilize the prices of all consumption categories. If prices are sticky, monetary policy then must trade off relative price distortions within different categories of consumption. Optimally, more weight should be placed on stabilizing goods and services prices that are less flexible. Calibrating a simple stickyprice model to U.S. data, we find that slight deflation is optimal, even absent transactions frictions leading to a demand for money. Optimality of deflation derives from the fact that relative prices have been trending up for services, whose nominal prices seem to be less flexible.

Keywords: relative price trends, sticky prices, optimal rate of inflation

JEL Classification: E31, E52, E58

Suggested Citation

Wolman, Alexander L., The Optimal Rate of Inflation with Trending Relative Prices (March 3, 2009). FRB Richmond Working Paper No. 09-2. Available at SSRN: https://ssrn.com/abstract=2188515 or http://dx.doi.org/10.2139/ssrn.2188515

Alexander L. Wolman (Contact Author)

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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