The Optimal Inflation Rate with Discount Factor Heterogeneity

Lepetit, Antoine

doi:10.17016/feds.2018.086

Cited by 8 publications

(8 citation statements)

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“…Somewhat related, Adam and Weber (2017) show that, even without any ZLB concern, optimal inflation might be positive in the context of a model with heterogeneous firms and systematic firm-level productivity trends. Finally, using a perpetual youth model, Lepetit (2017) shows that optimal inflation can be positive in the presence of heterogeneous discount factor, especially when the social planner is more patient than agents.…”

Section: Related Literaturementioning

confidence: 98%

The Optimal Inflation Target and the Natural Rate of Interest

Andrade¹,

Galı́²,

Bihan³

et al. 2019

Brookings Papers on Economic Activity

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We study how changes in the value of the steady-state real interest rate affect the optimal inflation target, both in the U.S. and the euro area, using an estimated New Keynesian DSGE model that incorporates the zero (or effective) lower bound on the nominal interest rate. We find that this relation is downward sloping, but its slope is not necessarily one-for-one: increases in the optimal inflation rate are generally lower than declines in the steady-state real interest rate. Our approach allows us not only to assess the uncertainty surrounding the optimal inflation target, but also to determine the latter while taking into account the parameter uncertainty facing the policy maker, including uncertainty with regard to the determinants of the steady-state real interest rate. We find that in the currently empirically relevant region for the US as well as the euro area, the slope of the curve is close to-0.9. That finding is robust to allowing for parameter uncertainty.

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Section: Related Literaturementioning

confidence: 98%

The Optimal Inflation Target and the Natural Rate of Interest

Andrade¹,

Galı́²,

Bihan³

et al. 2019

Brookings Papers on Economic Activity

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“…Following Schmitt-Grohé and Uribe (2010), a zero inflation rate is considered optimal in the framework of the New Keynesian Model with sticky nominal prices. However, optimal slightly positive inflation rates result from the introduction of a zero lower bound on nominal interest rates (Andrade et al, 2018), labor market frictions (Carlsson and Westermark, 2016), or heterogeneous discount factors (Lepetit, 2018). Along this line, Adam and Weber (2019) show that the optimal inflation rate may be positive if firms' levels of productivity are heterogeneous and prices are sticky.…”

Section: Introductionmentioning

confidence: 99%

Eurozone Prices: A Tale of Convergence and Divergence

2020

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The Working Paper Series seeks to disseminate original research in economics and fi nance. All papers have been anonymously refereed. By publishing these papers, the Banco de España aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment.The opinions and analyses in the Working Paper Series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem.The Banco de España disseminates its main reports and most of its publications via the Internet at the following website: http://www.bde.es.Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

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“…Somewhat related, Adam and Weber (2019) show that, even without any ZLB concern, optimal inflation might be positive in the context of a model with heterogeneous firms and systematic firm-level productivity trends. Finally, Lepetit (2018) shows that optimal inflation can be different from zero when profits and utility flows are discounted at different rates, as is generally the case in overlapping-generation models. In a parameterized example of the latter he shows the optimal steady-state inflation is significantly above zero.…”

Section: Related Literaturementioning

confidence: 88%

The Optimal Inflation Target and the Natural Rate of Interest

Andrade¹,

Galı́²,

Bihan³

et al. 2019

Federal Reserve Bank of Boston Research Department Working Papers

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We study how changes in the steady-state real interest rate affect the optimal inflation target in a New Keynesian DSGE model with trend inflation and a lower bound on the nominal interest rate. In this setup, a lower steady-state real interest rate increases the probability of hitting the lower bound. That effect can be counteracted by an increase in the inflation target, but the resulting higher steadystate inflation has a welfare cost in and of itself. We use an estimated DSGE model to quantify that tradeoff and determine the implied optimal inflation target, conditional on the monetary policy rule in place before the financial crisis. The relation between the steady-state real interest rate and the optimal inflation target is downward sloping. While the increase in the optimal inflation rate is in general smaller than the decline in the steady-state real interest rate, in the currently empirically relevant region the slope of the relation is found to be close to -1. That slope is robust to allowing for parameter uncertainty. Under "make-up" strategies such as price level targeting, the required increase in the optimal inflation target under a lower steady-state real interest rate is, however, much smaller.

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The Optimal Inflation Rate with Discount Factor Heterogeneity

Cited by 8 publications

References 47 publications

The Optimal Inflation Target and the Natural Rate of Interest

The Optimal Inflation Target and the Natural Rate of Interest

Eurozone Prices: A Tale of Convergence and Divergence

The Optimal Inflation Target and the Natural Rate of Interest

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