Is the optimal rate of inflation negative?

In the light of the current situation inflation targeting has come under considerable criticism (See here and here).  According to at least one critique by targeting low but positive CPI grow, monetary authorities in the USA, in Europe, and in the UK forced short-term interests too low, and encouraged or allowed asset price inflation to spiral. The suggestion that is implicit in this criticism is that either central banks should target a broader measure of inflation, or they should target a lower rate of inflation.   

Here is a very interesting post about the optimal rate of inflation. It is interesting because it mentions a paper that presents a New Keynesian model that produces an negative optimal rate of inflation. This resurrects the view expressed by many economists in the 1920s that the ideal price level was determined by productivity (There is a fascinating paper by George Selgin entitled The ‘Productivity Norm’versus Zero Inflation in the History of Economic Thought which is not online unfortunately).

According to this view, since all else equal as productivty increases, the amount of goods that a given unit of labour can purchase should also increase, productivity growth should result in mild deflation. The productivity norm was held to be more desirable than stable prices or mild inflation because it allowed prices to do best reflect the true underlying scarcities in the economy whereas as monetary expansion always led to relative prices being slightly distorted because it touched some prices before others.

So much for the history of the idea. I think that further research should be directed at measuring the costs of inflation. And my feeling is that this idea will look a lot less waky in a few years time than it does now.

Comments

[Gabriel]

I'm surprised to see the words "Friedman rule" missing.

[Mark]

Fair point but I think people are quite familiar with the Friedman rule already so I would mention something a little more esoteric. Plus the Friedman rule suffers seriously from the difficulty of measuring the money supply.

[Gabriel]

No, I mean this: http://en.wikipedia.org/wiki/Friedman_rule which is different from k%.

i = pi + r
i = 0 => pi = -r
But then r = f'(k)

Negative inflation, zero nominal interest rate, productivity, etc. ... it's all in Friedman's rule.

[Mark]

Thanks for the correction Gabriel, the Friedman rule seems to be a blind spot of mine. Perhaps the main difference between them is that the Friedman rule rectifies neoclassical inefficiencies associated with insufficiency liquidity whereas as the justification for a productivity norm was more Austrian.