The Optimal Rate of Inflation
Observed inflation targets around the industrial world are concentrated at two percent per year. This chapter investigates the extent to which the observed magnitudes of inflation targets are consistent with the optimal rate of inflation predicted by leading theories of monetary nonneutrality. We find that consistently those theories imply that the optimal rate of inflation ranges from minus the real rate of interest to numbers insignificantly above zero. Furthermore, we argue that the zero bound on nominal interest rates does not represent an impediment for setting inflation targets near or below zero.
This paper was written for the Elsevier/North-Holland Handbook of Monetary Economics, Volume 3, edited by Benjamin M. Friedman and Michael Woodford. We thank Jordi Gali and Pedro Teles for comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
“The Optimal Rate of Inflation,” (with Mart ́ın Uribe), in Handbook of Monetary Economics edited by Benjamin M. Friedman and Michael Woodford, Volume 3B, Elsevier, San Diego CA, 2011, 653-722.