IMF Working Papers

On Price Stability and Welfare

By Etienne B Yehoue

July 1, 2012

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Etienne B Yehoue. On Price Stability and Welfare, (USA: International Monetary Fund, 2012) accessed October 12, 2024
Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

The financial crisis in the advanced countries that began in 2007 has led central bankers to adopt unconventional policy measures as policy interest rates neared the zero bound. One suggestion (Blanchard, Dell’Ariccia, and Mauro, 2010) has been to raise inflation targets to provide more room for policy rate easing during crises. This paper addresses a different issue: the relationship between inflation and welfare. The literature is surveyed and a model is developed. A key conclusion is that an increase in inflation targets gives rise to additional welfare costs, even after the extra room to maneuver above the zero lower bound for nominal policy rates is taken into account. Based on parameter values that fit U.S. data, the additional welfare costs of raising inflation targets from 2 to 4 percent are estimated at about 0.3 percent of annual real income. A rise to 10 percent would yield additional welfare costs of about 1 percent of real income. Other parameter values yield welfare costs as high as 7 (respectively 30) percent of real income for raising inflation targets from 2 to 4 (respectively from 2 to 10) percent. The full costs of raising inflation targets are likely to be higher because the model used to generate these estimates does not account for higher inflation-induced volatility.

Subject: Demand for money, Financial services, Inflation, Inflation targeting, Monetary policy, Money, National accounts, Personal income, Prices, Real interest rates

Keywords: Demand for money, Inflation, Inflation dynamics, Inflation expectation, Inflation target, Inflation targeting, Inflation-growth relationship, Interest rates, Monetary policy, Money demand, Personal income, Real interest rate, Real interest rates, Welfare, Welfare cost, WP

Publication Details

  • Pages:

    36

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2012/189

  • Stock No:

    WPIEA2012189

  • ISBN:

    9781475505375

  • ISSN:

    1018-5941