Generational War on Inflation: Optimal Inflation Rates for the Young and the Old

Abstract

How does a grayer society affect the political decision-making regarding inflation rates? Is deflation preferred as a society ages? In order to answer these questions, we compute the optimal inflation rates for the young and the old respectively, and explore how they change with demographic factors, by using a New Keynesian model with overlapping generations. According to our simulation results, there indeed exists a tension between the young and the old on the optimal inflation rates, with the optimal inflation rates differing between generations. The rates can be significantly different from zero, particularly, when heterogeneous impacts from inflation via nominal asset holdings are considered. The optimal inflation rates for the old can be largely negative, reflecting their positive nominal asset holdings as well as lower effective discount factor. Societal aging may exert downward pressure on inflation rates through a politico-economic mechanism.