Finance and Economics Discussion Series (FEDS)
February 2013
Welfare Costs of Shifting Trend Inflation
Abstract:
This paper studies the welfare consequences of exogenous variations in trend inflation in a New Keynesian economy. Consumption and leisure respond asymmetrically to a rise and a decline in trend inflation. As a result, an increase in the variance of shocks to the trend inflation process decreases welfare not only by increasing the volatilities of consumption and leisure, but also by decreasing their average levels. I find that the welfare cost of drifting trend inflation is modest and that it comes mainly from reduced average levels of consumption and leisure, not from their increased volatilities.
Full paper (Screen Reader Version)Keywords: Great inflation, second-order approximation, trend inflation, welfare
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