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

Optimal Inflation Target in an Economy with Menu Costs and a Zero Lower Bound† AbstractI 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 E12, E31, E32, E42, E52) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Journal: Macroeconomics American Economic Association

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

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

Blanco, Andrés
American Economic Journal: Macroeconomics , Volume 13 (3) – Jul 1, 2021

Abstract

AbstractI 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 E12, E31, E32, E42, E52)

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References (67)

Publisher
American Economic Association
Copyright
Copyright © 2021 © American Economic Association
ISSN
1945-7715
DOI
10.1257/mac.20180198
Publisher site
See Article on Publisher Site

Abstract

AbstractI 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 E12, E31, E32, E42, E52)

Journal

American Economic Journal: Macroeconomics – American Economic Association

Published: Jul 1, 2021

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