The Optimal Inflation Rate with Discount Factor Heterogeneity

58 Pages Posted: 26 Dec 2018 Last revised: 21 Feb 2019

See all articles by Antoine Lepetit

Antoine Lepetit

Board of Governors of the Federal Reserve System

Date Written: 2018-12

Abstract

This paper shows that deviations from long-run price stability are optimal in the presence of price stickiness whenever profit and utility flows are discounted at a different rate. In that case, a monetary authority acting under commitment will choose a path for the inflation rate that ends with a non-zero value. Such a property is relevant in a wide range of macroeconomic environments. I first illustrate this by studying optimal monetary policy in a New Keynesian model with a perpetual youth structure. In this setting, profit flows are discounted more heavily than utility flows and the optimal inflation target is equal to 3.2 percent in a baseline calibration of the model. I also show that this property leads to a positive long-run inflation rate in models with firm entry and exit and in environments with search and matching frictions in the labor market and another form of nominal rigidity, wage stickiness.

Keywords: Discount factor heterogeneity, Inflation target, Optimal inflation rate, Optimal monetary policy, Perpetual youth, Sticky prices

JEL Classification: E31, E32, E52

Suggested Citation

Lepetit, Antoine, The Optimal Inflation Rate with Discount Factor Heterogeneity (2018-12). FEDS Working Paper No. 2018-086. Available at SSRN: https://ssrn.com/abstract=3306148 or http://dx.doi.org/10.17016/FEDS.2018.086

Antoine Lepetit (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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