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U.S. TREND INFLATION REINTERPRETED: THE ROLE OF FISCAL POLICIES AND TIME-VARYING NOMINAL RIGIDITIES

Published online by Cambridge University Press:  21 March 2014

Nicola Acocella ,
Giovanni Di Bartolomeo  and
Patrizio Tirelli
Nicola Acocella
Affiliation:
Sapienza University of Rome
Giovanni Di Bartolomeo*
Affiliation:
Sapienza University of Rome
Patrizio Tirelli
Affiliation:
University of Milan Bicocca
*
Address correspondence to: Giovanni Di Bartolomeo, Department of Economics and Law, Sapienza University of Rome, Via del Castro Laurenziano, 9,00161 Rome, Italy; e-mail: giovanni.dibartolomeo@uniroma1.it.
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Abstract

This paper offers a reinterpretation of the Fed's time-varying implicit inflation target, based on two considerations. The first is that the need to alleviate the burden of distortionary taxation may justify the choice of a positive inflation rate. The second is based on compelling evidence that the degree of price and wage indexation falls with trend inflation. In fact, we find that a proper characterization of the joint evolution of fiscal variables and nominal rigidities has a strong impact on the Ramsey optimal policies, implying optimal inflation dynamics that are consistent with the observed evolution of U.S. trend inflation. By contrast, tax policies have been too lax, especially at the time of the controversial Bush tax cuts.

Keywords

Trend InflationMonetary and Fiscal PolicyRamsey Plan
Type
Articles
Information
Macroeconomic Dynamics , Volume 19 , Special Issue 6: Growth, Optimal Fiscal and Monetary Policy, and Financial Frictions , September 2015 , pp. 1294 - 1308
Copyright
Copyright © Cambridge University Press 2014 

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