Nominal Rigidities and the Optimal Rate of Inflation

Aarhus Economics Working Paper 2000-19

24 Pages Posted: 27 Jan 2001

See all articles by Torben M. Andersen

Torben M. Andersen

University of Aarhus - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Date Written: December 2000

Abstract

Inflation may enhance the efficiency of the price system in the presence of nominal rigidities. For the price system to function efficiently there is a need for nominal prices to adjust both to real and nominal shocks for relative prices to disseminate the appropriate signals. Since the incentive for price setters to change prices depends not only on the costs of changing prices but also on the realized shocks, it follows that the rate of inflation may affect the incentive to change prices. The higher the rate of inflation the larger the incentive to change prices, and in the presence of real shocks requiring adjustment of relative prices this may lead to a better functioning price system. Empirical evidence supports that nominal rigidities are more prevalent at low rates of inflation. It follows that there can be welfare costs of targeting inflation at too low a level.

JEL Classification: E20, E30

Suggested Citation

Andersen, Torben M., Nominal Rigidities and the Optimal Rate of Inflation (December 2000). Aarhus Economics Working Paper 2000-19, Available at SSRN: https://ssrn.com/abstract=258018 or http://dx.doi.org/10.2139/ssrn.258018

Torben M. Andersen (Contact Author)

University of Aarhus - Department of Economics ( email )

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