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On the welfare and cyclical implications of moderate trend inflation

Guido Ascari, Louis Phaneuf and Eric R. Sims

Journal of Monetary Economics, 2018, vol. 99, issue C, 56-71

Abstract: The welfare and cyclical implications of moderate trend inflation are addressed in an augmented medium-scale DSGE model. Increasing trend inflation from 2 to 4 percent generates a consumption-equivalent welfare loss of about 4 percent. Welfare costs of this magnitude are driven by: staggered wage contracts, trend growth, extended borrowing, a roundabout production structure, and the interaction between trend inflation and shocks to the marginal efficiency of investment (MEI). A sticky-price model abstracting from these features generates much smaller losses. Moderate trend inflation also has important business-cycle implications, interacting much more strongly with MEI shocks than with productivity or monetary shocks.

Keywords: Trend inflation; Roundabout production; Investment shocks; Inflation costs; Business cycles (search for similar items in EconPapers)
JEL-codes: E31 E32 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:moneco:v:99:y:2018:i:c:p:56-71