Optimal Trend Inflation and Monetary Policy under Trending Relative Prices

Toyoichiro Shirota

No 07-E-1, Bank of Japan Working Paper Series from Bank of Japan

Abstract: In the standard new Keynesian models, the optimal inflation rate is zero while the long-run inflation rate is non-zero positive in many countries. In this paper, we provide a new rationale for the non-zero trend inflation by utilizing the productivity gap between the intermediate-goods sector and the final-goods sector. The productivity gap among the sectors creates the relative price trend of the CPI and the PPI, which is observed in the actual data. Then, we show that the Ramsey-optimal inflation rate of the CPI is positive while that of the PPI is negative. In addition, the efficient allocation cannot be achieved under the productivity gap. Finally, we investigate the optimal monetary policy response to a shock under the trend inflation. Our results suggest that non-zero trend inflation dramatically alters the optimal monetary policy.

Keywords: Trend inflation; CPI; PPI; Optimal monetary policy; Relative price trend; Sectoral productivity gap (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Date: 2007-01
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:boj:bojwps:07-e-1

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