Estimating the Optimal Inflation Target from Trends in Relative Prices
American Economic Journal: Macroeconomics
vol. 15,
no. 3, July 2023
(pp. 1-42)
Abstract
We derive closed-form expressions for the optimal inflation target under Calvo and menu-cost frictions in a model featuring a product life cycle and multiple sources of heterogeneity across goods. We show that both frictions deliver the same optimal target and how it can be estimated from observed trends in relative prices. Using micro price data underlying the CPI in the United Kingdom, we document that relative prices fall over the product lifetime in most expenditure items. This causes the optimal inflation target to be positive, with our baseline estimate for the United Kingdom being equal to 2.6 percent in 2016. The optimal target has steadily increased over the prior two decades due to an acceleration in the rates of relative price decline over time.Citation
Adam, Klaus, and Henning Weber. 2023. "Estimating the Optimal Inflation Target from Trends in Relative Prices." American Economic Journal: Macroeconomics, 15 (3): 1-42. DOI: 10.1257/mac.20200320Additional Materials
JEL Classification
- C51 Model Construction and Estimation
- D15 Intertemporal Household Choice; Life Cycle Models and Saving
- E31 Price Level; Inflation; Deflation
- L11 Production, Pricing, and Market Structure; Size Distribution of Firms
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