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Inflation and Social Welfare in a New Keynesian Model: The Case of Japan and the U.S.


June 27, 2019
Tomohide Mineyama*1
Wataru Hirata*2
Kenji Nishizaki*3


In this paper, we investigate the steady-state inflation rate that maximizes social welfare in a New Keynesian model. We calibrate the model on the Japanese and the U.S. economies, and we solve the model employing a computation method that addresses the non-linear dynamics associated with four major factors affecting the costs and benefits of inflation: (i) nominal price rigidity; (ii) money holdings; (iii) downward nominal wage rigidity (DNWR); and (iv) the zero lower bound of the nominal interest rates (ZLB). The calibrated model suggests the steady-state inflation rate that maximizes social welfare is close to two percent for both Japan and the U.S., though the main driver differs by country: the ZLB for Japan, but the DNWR for the U.S. In addition, around one percentage point absolute deviation from the close-to-two-percent rate induces only a minor change in social welfare. We also find that the lower-end of the range that is acceptable in terms of welfare losses is reduced when we introduce forward guidance in monetary policy through which private agents anticipate a prolonged zero interest rate once the ZLB binds. The estimates of the steady-state inflation rate are subject to a considerable margin of error due to parameter uncertainty in ZLB parameterization.

JEL Classification
E31; E43; E52

Inflation; Social welfare; New Keynesian model; Downward nominal wage rigidity; Zero lower bound; Forward guidance

This work was presented at the Eighth Joint Conference Organized by the University of Tokyo Center for Advanced Research in Finance and the Bank of Japan Research and Statistics Department. The authors are grateful to Kosuke Aoki, Susanto Basu, Yuriy Gorodnichenko, Joshua Hausman, Hibiki Ichiue, Peter Ireland, Tomiyuki Kitamura, Takushi Kurozumi, and participants of the seminar at the Bank of Japan and the conference above for their helpful comments and discussions. Any remaining errors are the sole responsibility of the authors. The views expressed in this paper are those of the authors and do not necessarily reflect the official views of the Bank of Japan.

  1. *1Monetary Affairs Department, Bank of Japan
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  2. *2Monetary Affairs Department, Bank of Japan
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  3. *3Monetary Affairs Department, Bank of Japan
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