ON THE WELFARE AND CYCLICAL IMPLICATIONS OF MODERATE TREND INFLATION

Nov 2018

Journal of Monetary Economics, Vol. 99, November 2018, Pages 56-71

DOI: https://doi.org/https://doi.org/10.1016/j.jmoneco.2018.06.001

The welfare and cyclical implications of moderate trend inflation are addressed in an augmented medium-scale DSGE model. Increasing trend inflation from 2 to 4 percent generates a consumption-equivalent welfare loss of about 4 percent. Welfare costs of this magnitude are driven by: staggered wage contracts, trend growth, extended borrowing, a roundabout production structure, and the interaction between trend inflation and shocks to the marginal efficiency of investment (MEI). A sticky-price model abstracting from these features generates much smaller losses. Moderate trend inflation also has important business-cycle implications, interacting much more strongly with MEI shocks than with productivity or monetary shocks.

Department Author

Guido Ascari


View Publication