Inflation persistence and optimal positive long-run inflation

Pontiggia, Dario (2007): Inflation persistence and optimal positive long-run inflation.

Abstract

Within New Keynesian economics, the optimality of a monetary policy that aims at zero inflation is surprisingly robust. Optimal monetary policy has this character despite the inefficiency of the nonstochastic steady state and despite the existence of a positively sloped long-run Phillips-curve trade-off. Full price stability remains optimal even under inflation persistence due to backward-looking price indexation by price setters. We show how extending a basic New Keynesian model to the case of inflation persistence due to backward-looking rule-of-thumb behaviour by price setters breaks the surprising robustness of zero long-run inflation target, namely backward-looking rule-of-thumb behaviour by price setters results in optimal positive long-run inflation. Comparing different theoretical explanations for structural inflation persistence suggests that the features that seem capable of delivering an endogenously optimal inflation target are costly disinflation, long-run Phillips-curve trade-off, and steady-state distortions.

• Item Type: MPRA Paper
• Institution: University of Glasgow, University of Milano-Bicocca
• Language: English
• Keywords: Optimal monetary policy; inflation persistence
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation

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