Hostname: page-component-6b989bf9dc-cvxtj Total loading time: 0 Render date: 2024-04-14T14:25:31.024Z Has data issue: false hasContentIssue false

HYPERBOLIC DISCOUNTING AND POSITIVE OPTIMAL INFLATION

Published online by Cambridge University Press:  09 February 2012

Liam Graham*
Affiliation:
University College London
Dennis J. Snower
Affiliation:
Kiel Institute for the World Economy, Christian-Albrechts University, CEPR and IZA
*
Address correspondence to: Liam Graham, Department of Economics, University College London, Gower Street, London WC1E 6BT, UK; e-mail: Liam.Graham@ucl.ac.uk.

Abstract

The Friedman rule states that steady-state welfare is maximized when there is deflation at the real rate of interest. Recent work by Khan, King, and Wolman [Review of Economic Studies 10 (4), 825–860] uses a richer model but still finds deflation optimal. In an otherwise standard New Keynesian model we show that, if households have hyperbolic discounting, small positive rates of inflation can be optimal. In our baseline calibration, the optimal rate of inflation is 2.1% and remains positive across a wide range of calibrations.

Type
Articles
Copyright
Copyright © Cambridge University Press 2012

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Amano, Robert, Moran, Kevin, Murchison, Stephen, and Rennison, Andrew (2007) Trend Inflation, Wage and Price Rigidities, and welfare. Working Papers 07-42, Bank of Canada.Google Scholar
Ascari, Guido (1998) Superneutrality of money in staggered wage-setting models. Macroeconomic Dynamics 2, 383400.CrossRefGoogle Scholar
Bakhshi, Hasan, Burriel-Llombart, Pablo, Khan, Hashmat, and Rudolf, Barbara (2003) Endogenous Price Stickiness, Trend Inflation, and the New Keynesian Phillips Curve. Working paper 191, Bank of England.CrossRefGoogle Scholar
Barro, Robert J. (1999) Ramsey meets Laibson in the neoclassical growth model. Quarterly Journal of Economics 114 (4), 11251152.CrossRefGoogle Scholar
Benigno, Pierpaolo (2004) Optimal monetary policy in a currency area. Journal of International Economics, 63 (2), 293320.CrossRefGoogle Scholar
Billi, Roberto M. and Khan, George A. (2008) What is the optimal inflation rate? Economic Review, Federal Reserve Bank of Kansas City Q II, 528.Google Scholar
Brown, Donna, Ingram, Peter, and Wadsworth, Jonathan (2004) Everyone's a Winner? Union Effects on Persistence in Private Sector Wage Settlements: Longitudinal Evidence from Britain. Department of Economics discussion papers 1104, Department of Economics, University of Surrey.Google Scholar
Bruno, M. and Jeffery, D. Sachs (1985) The Economics of Worldwide Stagflation. Oxford, UK: Blackwell.CrossRefGoogle Scholar
Caplin, Andrew and Leahy, John (2004) The social discount rate. Journal of Political Economy, 112 (6), 12571268.CrossRefGoogle Scholar
Card, David (1983) Cost of living escalators in major union contracts. Industrial and Labor Relations Review 37, 3448.CrossRefGoogle Scholar
Card, David (1986) An empirical model of wage indexation provisions in union contracts. Journal of Political Economy 94 (3), S144S175.CrossRefGoogle Scholar
Christofides, Louis N. and Leung, Man Tuen (2003) Nominal wage rigidity in contract data: A parametric approach. Economica 70 (280), 619638.CrossRefGoogle Scholar
Dixit, Avinash K. and Stiglitz, Joseph E. (1977) Monopolistic competition and optimum product diversity. American Economic Review 67 (3), 297308.Google Scholar
Erceg, Christopher J., Henderson, Dale W., and Levin, Andrew T. (2000) Optimal monetary policy with staggered wage and price contracts. Journal of Monetary Economics 46, 281313.CrossRefGoogle Scholar
Fredrick, Shane, Loewenstein, George, and O'Donoghue, Ted (2002) Time discounting and time preference: A critical review. Journal of Economic Literature 40, 351401.CrossRefGoogle Scholar
Gomme, Paul (1993) Money and growth revisited: Measuring the costs of inflation in an endogenous growth model. Journal of Monetary Economics 32, 5177.CrossRefGoogle Scholar
Graham, Liam and Snower, Dennis J. (2004) The Real Effects of Money Growth in Dynamic General Equilibrium. Working paper 412, European Central Bank.CrossRefGoogle Scholar
Graham, Liam and Snower, Dennis J. (2008) Hyperbolic discounting and the Phillips curve. Journal of Money, Credit and Banking 40 (2–3), 427448.CrossRefGoogle Scholar
Groth, Charlotta and Johansson, Asa (2004) Bargaining structure and nominal wage flexibility. European Economic Review 48 (6), 13491365.CrossRefGoogle Scholar
Hansen, G.D. (1985) Indivisible labor and the business cycle. Journal of Monetary Economics 16 (3), 309327.CrossRefGoogle Scholar
Huang, Kevin X.D. and Liu, Zheng (2002) Staggered price setting, staggered wage setting and business cycle persistence. Journal of Monetary Economics 49, 405433.CrossRefGoogle Scholar
Huffman, David and Barenstein, Matias (2005) A Monthly Struggle for Self-Control? Hyperbolic Discounting, Mental Accounting, and the Fall in Consumption Between Paydays. IZA Discussion paper 1430.Google Scholar
İmrohoroğlu, Ayse, İmrohoroğlu, Selahattin, and Joines, Douglas H. (2003) Time-inconsistent preferences and social security. Quarterly Journal of Economics 118 (2), 745784.CrossRefGoogle Scholar
Kaufman, Roger T. and Woglom, Geoffrey (1986) The degree of indexation in major U.S. union contracts. Industrial and Labor Relations Review, 39 (3), 439448.CrossRefGoogle Scholar
Khan, Aubhik, King, Robert G., and Wolman, Alexander L. (2003) Optimal monetary policy. Review of Economic Studies 10 (4), 825860.CrossRefGoogle Scholar
Laibson, David (1996) Hyperbolic Discount Functions, Undersaving, and Savings Policy. NBER working paper 5635.CrossRefGoogle Scholar
Laibson, David (1997) Golden eggs and hyperbolic discounting. Quarterly Journal of Economic 112 (2), 443477.CrossRefGoogle Scholar
Laibson, David, Repetto, Andrea, and Tobacman, Jeremy (2007) Estimating Discount Functions with Consumption Choices over the Lifecycle. NBER working paper 13314.CrossRefGoogle Scholar
Levin, Andrew and Yun, Tack (2007) Reconsidering the natural rate hypothesis in a New Keynesian framework. Journal of Monetary Economics 54 (5), 13441365.CrossRefGoogle Scholar
Lucas, R.E. Jr., (2000) Inflation and welfare. Econometrica 68 (2), 247274.CrossRefGoogle Scholar
Marinakis, Andrés E. (1997) Wage policy in high inflation countries: The role of indexation in Latin America during the 1980s. Journal of Economic Studies 24 (6), 356378.CrossRefGoogle Scholar
Mastrobuoni, Giovanni and Weinberg, Matthew (2009) Heterogeneity in intra-monthly consumption patterns, self-control, and savings at retirement. American Economic Journal: Economic Policy 2, 163189.Google Scholar
Mendoza, Enrique G., Razin, Assaf, and Tesar, Linda L. (1994) Effective tax rates in macroeconomics: Cross-country estimates of tax rates on factor incomes and consumption. Journal of Monetary Economics 34 (3), 297323.CrossRefGoogle Scholar
Romer, David (1990) Staggered price setting with endogenous frequency of adjustment. Economics Letters 32 (3), 205210.CrossRefGoogle Scholar
Shapiro, Jesse (2005) Is there a daily discount rate? Evidence from the food stamp nutrition cycle. Journal of Public Economics 89 (2–3), 303325.CrossRefGoogle Scholar
Sinclair, Peter J.N. (2003) The Optimal Rate of Inflation: An Academic Perspective. Bank of England Quarterly Bulletin 2000 (Autumn), 343–351.Google Scholar
Smith, Jennifer C. (2000) Nominal wage rigidity in the United Kingdom. Economic Journal 110 (462), C176C195.CrossRefGoogle Scholar
Taylor, John (1979) Staggered wage setting in a macro model. American Economic Review 69 (2), 108113.Google Scholar
Taylor, John (1999) Staggered price and wage setting in macroeconomics. In Taylor, John. B. and Woodford, Michael (eds.), Handbook of Macroeconomics, chap. 15, pp. 10091050. Elsevier.CrossRefGoogle Scholar
Vroman, Wayne (1985) Cost-of-living escalators and price–wage linkages in the U.S. economy, 1968–1980. Industrial and Labor Relations Review 38 (2), 225235.Google Scholar
Woodford, Michael (2003) Interest and Prices. Princeton, NJ: Princeton University Press.Google Scholar