The Korean Journal of Economic Studies
Borrowing Constraints and Optimal Inflation Rate
Yongseung Jung(Kyung Hee University), Yang Su Park(The Bank of Korea)Year 2016Vol. 64No. 2
AbstractThis paper sets up a sticky price model where both asset holders andnon-asset holders exist to discuss its implication on optimal inflation rate. Ina canonical new Keynesian model with external habit and financial marketfrictions, optimal inflation rate depends on the available tax instruments as wellas the debt/GDP ratio. If a state-contingent tax policy can be employed tocompletely eliminate time-varying distortions associated with external habit,goods market and financial market fictions, then optimal inflation rate is nil.However, if state-contingent tax and lump-sum tax are not available, there isa trade-off between output stabilization and price stabilization. If thegovernment has to maintain a constant debt/GDP ratio with time-invariant taxpolicy, then optimal inflation rate is about 1 percent in the economy withexternal habit, goods and financial market frictions.