The optimal rate of inflation: an academic perspective

Quarterly Bulletin 2003 Q3
Published on 26 September 2003

By Peter Sinclair, Houblon-Norman Fellow and Professor of Economics at the University of Birmingham. 

In an economy free of all imperfections, inflation should be slightly negative. Prices should keep dropping, at the real rate of interest. Any higher rate of sustained inflation (or lower deflation) would reduce the benefits from holding real money. Central banks typically aim for modest positive inflation, however. This article explores five types of imperfection: inertia in nominal prices, the need for distorting taxes, market power for retail banks, the value of the option to cut nominal interest rates in bad times, and menu costs. It concludes that the combined effect of these imperfections is in practice likely to justify a small positive rate of inflation.

PDFThe optimal rate of inflation: an academic perspective

Other Quarterly Bulletin 2003 Q3 articles

Was this page useful?
Add your details...