The Optimal Inflation Rate with Discount Factor Heterogeneity

Abstract

AbstractI show that adding an overlapping generations structure to the canonical New Keynesian model can generate an optimal inflation rate that is significantly positive. In a baseline calibration of the model, the optimal inflation target is comprised between 0.8% and 3.2% in annual terms. In this framework, deviations from long‐run price stability are optimal because the rate at which firms discount future profit flows naturally differs from the rate at which the planner discounts future utility flows.