Innovation Choice, Product Life Cycles, and Optimal Trend Inflation

Hiroshi Inokuma, Mitsuru Katagiri and Nao Sudo
Additional contact information
Hiroshi Inokuma: Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: hiroshi.inokuma@boj.or.jp)
Mitsuru Katagiri: Associate Professor, Faculty of Business Administration, Hosei University (E-mail: mitsuru.katagiri@hosei.ac.jp)
Nao Sudo: Deputy Director-General, Financial System and Bank Examination Department (E-mail: nao.sudou@boj.or.jp)

No 24-E-17, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: This study revisits the old and ongoing challenge of identifying the optimal trend inflation rate, using a novel model that incorporates a firm's innovation choices, product life cycles, and the interplay of the two factors. We construct an endogenous growth model with sticky prices, where firms have two options: to be an innovator or to be a follower. An innovator causes creative destruction, forcing all the incumbents to exit, and becomes a monopolist in its sector. A follower enters an existing sector by offering a product that is slightly different from the incumbent's products, inducing a product life cycle within the sector. Trend inflation impacts the firm's decision regarding which of the two options to choose by changing expected markups and profits. We show that the optimal trend inflation rate could exceed zero as it mitigates potential innovator losses upon the entry of followers, which in turn depresses the incentives for firms to be followers, promoting creative destruction and faster economic growth.

Keywords: Sticky prices; Optimal inflation; Product life cycle; Innovation; Productivity growth; Markups (search for similar items in EconPapers)
JEL-codes: E31 O31 O41 (search for similar items in EconPapers)
Date: 2024-11
New Economics Papers: this item is included in nep-mon and nep-sbm
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