On the Optimal Inflation Rate

20 Pages Posted: 4 Apr 2016 Last revised: 24 Jun 2023

See all articles by Markus K. Brunnermeier

Markus K. Brunnermeier

Princeton University - Department of Economics

Yuliy Sannikov

Stanford GSB

Date Written: March 2016

Abstract

In our incomplete markets economy financial frictions affect the optimal inflation target. Households choose portfolios consisting of risky (uninsurable) capital and money. Money is a bubbly store of value. The market outcome is constrained Pareto inefficient due to a pecuniary externality. Each individual agent takes the real interest rate as given, while in the aggregate it is driven by the economic growth rate, which in turn depends on individual portfolio decisions. Higher inflation due to higher money growth lowers the real interest rate (on money) and tilts the portfolio choice towards physical capital investment. The optimal inflation target boosts growth and welfare and is higher for emerging market economies.

Suggested Citation

Brunnermeier, Markus Konrad and Sannikov, Yuliy, On the Optimal Inflation Rate (March 2016). NBER Working Paper No. w22133, Available at SSRN: https://ssrn.com/abstract=2758481

Markus Konrad Brunnermeier (Contact Author)

Princeton University - Department of Economics ( email )

Bendheim Center for Finance
Princeton, NJ
United States
609-258-4050 (Phone)
609-258-0771 (Fax)

HOME PAGE: http://www.princeton.edu/¡­markus

Yuliy Sannikov

Stanford GSB ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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