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HYPERBOLIC DISCOUNTING AND POSITIVE OPTIMAL INFLATION

Published online by Cambridge University Press:  09 February 2012

Liam Graham  and
Dennis J. Snower
Liam Graham*
Affiliation:
University College London
Dennis J. Snower
Affiliation:
Kiel Institute for the World Economy, Christian-Albrechts University, CEPR and IZA
*
Address correspondence to: Liam Graham, Department of Economics, University College London, Gower Street, London WC1E 6BT, UK; e-mail: Liam.Graham@ucl.ac.uk.
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Abstract

The Friedman rule states that steady-state welfare is maximized when there is deflation at the real rate of interest. Recent work by Khan, King, and Wolman [Review of Economic Studies 10 (4), 825–860] uses a richer model but still finds deflation optimal. In an otherwise standard New Keynesian model we show that, if households have hyperbolic discounting, small positive rates of inflation can be optimal. In our baseline calibration, the optimal rate of inflation is 2.1% and remains positive across a wide range of calibrations.

Keywords

Optimal Monetary PolicyInflation TargetingPhillips CurveNominal InertiaMonetary Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 17 , Issue 3 , April 2013 , pp. 591 - 620
Copyright
Copyright © Cambridge University Press 2012

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