The Optimal Inflation Target
Saturday, Jan. 5, 2019 10:15 AM - 12:15 PM
- Chair: Jón Steinsson, University of California-Berkeley
The Optimal Inflation Target and the Natural Rate of Interest
AbstractWe 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.
A Plucking Model of Business Cycles
AbstractThe dynamics of unemployment fit what Milton Friedman labeled a plucking model: a rise in unemployment is followed by a fall of similar amplitude, but the amplitude of the rise does not depend on the previous fall. We develop a microfounded plucking model of the business cycle to account for these phenomena. The model features downward nominal wage rigidity within an explicit search model of the labor market. Our search framework implies that downward nominal wage rigidity is fully consistent with optimizing behavior and equilibrium. We reassess the costs of business cycle fluctuations through the lens of the plucking model. Contrary to New-Keynesian models where fluctuations are cycles around an average natural rate, the plucking model generates fluctuations that are gaps below potential (as in Old-Keynesian models). In this model, business cycle fluctuations raise not only the volatility but also the average level of unemployment, and stabilization policy can reduce the average level of unemployment and therefore yield sizable welfare benefits.
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
- E3 - Prices, Business Fluctuations, and Cycles