Optimal Inflation Target in an Economy with Menu Costs and a Zero Lower Bound

Andrés Blanco

American Economic Journal: Macroeconomics, 2021, vol. 13, issue 3, 108-41

Abstract: I study the optimal inflation target in a quantitative menu cost model with a zero lower bound on interest rates. I find that the optimal inflation target is 3.5 percent, which is higher than in models commonly used for monetary policy analysis. Key to this result is that inflation has a small effect on resource misallocation when the model features firm-level shocks, which are necessary to match the empirical distribution of price changes. A higher inflation target decreases price flexibility at the zero lower bound, and through this mechanism, it reduces the severity of recessions when the monetary authority is constrained.

JEL-codes: E12 E31 E32 E42 E52 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (15)

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DOI: 10.1257/mac.20180198

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