The Optimal Inflation Rate Under Schumpeterian Growth

50 Pages Posted: 4 May 2015 Last revised: 5 May 2015

See all articles by Koki Oikawa

Koki Oikawa

Waseda University

Kozo Ueda

Waseda University; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

Date Written: May 1, 2015

Abstract

In this study, we analyze the relationship between inflation and economic growth. To this end, we construct a model of endogenous growth with creative destruction, incorporating sticky prices due to menu costs. Inflation and deflation reduce the reward for innovation via menu cost payments and, thus, lower the frequency of creative destruction. Central banks can maximize the rate of economic growth by setting their target inflation rate at the negative of a fundamental growth rate that would be realized without price stickiness. The optimal inflation rate, however, may differ from the growth-maximizing inflation rate because of overinvestment in R&D and indeterminacy. Both mechanisms indicate a higher optimal inflation rate than the negative of a fundamental growth rate. Our calibrated model shows that the optimal inflation rate is close to the growth-maximizing inflation rate and that a deviation from the optimal level has sizable impacts on economic growth.

Keywords: creative destruction, menu cost, new Keynesian, monetary policy

JEL Classification: E31, E58, O33, O41

Suggested Citation

Oikawa, Koki and Ueda, Kozo, The Optimal Inflation Rate Under Schumpeterian Growth (May 1, 2015). CAMA Working Paper No. 14/2015, Available at SSRN: https://ssrn.com/abstract=2602065 or http://dx.doi.org/10.2139/ssrn.2602065

Koki Oikawa

Waseda University ( email )

1-104 Totsukamachi, Shinjuku-ku
tokyo, 169-8050
Japan

Kozo Ueda (Contact Author)

Waseda University ( email )

1-104 Totsukamachi, Shinjuku-ku
tokyo, 169-8050
Japan

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

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