The Optimal Inflation Rate in New Keynesian Models

Olivier Coibion, Yuriy Gorodnichenko and Johannes Wieland

No 16093, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the effects of positive steady-state inflation and show that steady-state inflation affects welfare through three distinct channels: steady-state effects, the magnitude of the coefficients in the utility-function approximation, and the dynamics of the model. We solve for the optimal level of inflation in the model and find that, for plausible calibrations, the optimal inflation rate is low, less than two percent, even after considering a variety of extensions, including price indexation, endogenous price stickiness, capital formation, model-uncertainty, and downward nominal wage rigidities. On the normative side, price level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability.

JEL-codes: E3 E4 E5 (search for similar items in EconPapers)
Date: 2010-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mic and nep-mon
Note: EFG IFM ME
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Citations: View citations in EconPapers (23)

Published as Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.

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Journal Article: The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound? (2012)
Working Paper: The Optimal Inflation Rate in New Keynesian Models (2010)
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