Optimal Inflation for the U.S.

By Roberto M. Billi
April 2007
RWP 07-03
Research Division
Federal Reserve Bank of Kansas City

Abstract    

What is the correctly measured inflation rate that monetary policy should aim for in the long-run? This paper characterizes the optimal inflation rate for the U.S. economy in a New Keynesian sticky-price model with an occasionally binding zero lower bound on the nominal interest rate. Real-rate and mark-up shocks jointly determine the optimal inflation rate to be positive but not large. Even allowing for the possibility of extreme model misspecification, the optimal inflation rate is robustly below 1 percent. The welfare costs of optimal inflation and the lower bound are limited.

Keywords: Commitment, liquidity trap, long-run trade-off, nonlinear, robust control, stationary distribution


JEL classification: C63, E31, E52

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