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  3. American Economic Review
  4. February 2019
  5. Optimal Trend Inflation

Optimal Trend Inflation

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Abstract

Sticky price models featuring heterogeneous firms and systematic firm-level productivity trends deliver radically different predictions for the optimal inflation rate than their popular homogenous-firm counterparts: (i) the optimal steady-state inflation rate generically differs from zero and (ii) inflation optimally responds to productivity disturbances. We show this by aggregating a heterogeneous-firm model with sticky prices in closed form. Using firm-level data from the US Census Bureau, we estimate the historically optimal inflation path for the US economy: the optimal inflation rate ranges between 1 percent and 3 percent per year and displays a downward trend over the period 1977–2015.

Citation

Adam, Klaus, and Henning Weber. 2019. "Optimal Trend Inflation." American Economic Review, 109 (2): 702-37. DOI: 10.1257/aer.20171066

Additional Materials

JEL Classification

  • C51 Model Construction and Estimation
  • D24 Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
  • D25 Intertemporal Firm Choice: Investment, Capacity, and Financing
  • E31 Price Level; Inflation; Deflation
  • E52 Monetary Policy