Update on Research webinar 25 March - Klaus Adam (University of Mannheim, CEPR and CESIfo): Estimating the Optimal Inflation Target from Trends in Relative Prices

Please note that the presentation topic has been changed!

Research webinar 25 March - Klaus Adam (University of Mannheim, CEPR and CESIfo): Estimating the Optimal Inflation Target from Trends in Relative Prices

Co-author: Henning Weber (Deutsche Bundesbank)

Abstract

We document a new stylized fact for the life-cycle behavior of consumer prices: relative to a narrowly defined set of competing products, the price of individual products tends to fall over the product lifetime. This holds true for more than 90% of the expenditure items underlying the U.K. consumer price index. We show that this data feature has important normative implications by constructing a sticky-price model featuring a product life cycle and heterogeneous relative-price trends. We derive closed-form expressions for the optimal inflation target in this setting, showing that Calvo and menu-cost adjustment frictions deliver (to first-order accuracy) identical optimal targets. We then explain how the optimal target can be estimated from the observed trends in relative prices. For the U.K. economy, we find the optimal target to be equal to 2.6% in 2016 and to have steadily increased over the period 1996 to 2016. We show how changes in relative price trends contributed to this development

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