Optimal monetary policy under low trend inflation

Guido Ascari and Tiziano Ropele

No 647, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: In the monetary policy literature it is commonly assumed that trend inflation is zero, despite overwhelming evidence that zero inflation is neither empirically relevant nor a practical objective for central bank policy. We therefore extend the standard New Keynesian model to allow for positive trend inflation, showing that even low trend inflation has strong effects on optimal monetary policy and the dynamics of inflation, output, and interest rates. Under discretion, the efficient policy deteriorates and there is no guarantee of determinacy. Even with commitment, targeting non-zero trend inflation leads to substantial welfare losses. Our results serve as a warning against indiscriminate use of models assuming zero trend inflation.

Keywords: Optimal monetary policy; trend inflation (search for similar items in EconPapers)
JEL-codes: E31 E52 (search for similar items in EconPapers)
Date: 2007-11
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (95)

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Persistent link: https://EconPapers.repec.org/RePEc:bdi:wptemi:td_647_07

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