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The Optimal Inflation Target

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  • Klaus Adam
  • Henning Weber

Abstract

We review the academic literature investigating the economic determinants of the welfare optimal inflation target. We start with a bird’s-eye review of the academic literature covering the past 60 years. Up to the year 2010, the academic literature recommended optimal inflation targets that are either negative or zero. The subsequent literature incorporated new economic features and can rationalize also positive inflation targets. In our review, we discuss these features, especially the role of (i) productivity and unaccounted quality progress, (ii) the lowerbound constraint on nominal rates, (iii) nominal wage rigidity, and (iv) product turnover and product aggregation. In a final setup, we provide suggestions for further research on the topic.

Suggested Citation

  • Klaus Adam & Henning Weber, 2024. "The Optimal Inflation Target," CRC TR 224 Discussion Paper Series crctr224_2024_572, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2024_572
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp572
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    References listed on IDEAS

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    1. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404, National Bureau of Economic Research, Inc.
    2. Klaus Adam & Oliver Pfäuti & Timo Reinelt, 2020. "Falling Natural Rates, Rising Housing Volatility and the Optimal Inflation Target," CRC TR 224 Discussion Paper Series crctr224_2020_235, University of Bonn and University of Mannheim, Germany.
    3. Bilbiie, Florin O., 2008. "Limited asset markets participation, monetary policy and (inverted) aggregate demand logic," Journal of Economic Theory, Elsevier, vol. 140(1), pages 162-196, May.
    4. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(4), pages 1371-1406.
    5. Marvin Goodfriend & Robert G. King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296, National Bureau of Economic Research, Inc.
    6. Ascari, Guido & Ropele, Tiziano, 2007. "Optimal monetary policy under low trend inflation," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2568-2583, November.
    7. Mineyama, Tomohide, 2022. "Revisiting the optimal inflation rate with downward nominal wage rigidity: The role of heterogeneity," Journal of Economic Dynamics and Control, Elsevier, vol. 139(C).
    8. John Grigsby & Erik Hurst & Ahu Yildirmaz, 2021. "Aggregate Nominal Wage Adjustments: New Evidence from Administrative Payroll Data," American Economic Review, American Economic Association, vol. 111(2), pages 428-471, February.
    9. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(4), pages 1371-1406.
    10. Fernando Alvarez & Hervé Le Bihan & Francesco Lippi, 2016. "The Real Effects of Monetary Shocks in Sticky Price Models: A Sufficient Statistic Approach," American Economic Review, American Economic Association, vol. 106(10), pages 2817-2851, October.
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    More about this item

    Keywords

    optimal inflation; Ramsey policy; optimal rules; lower-bound constraint; wage rigidity; relative price trends;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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