The Optimal Rate of Inflation with Trending Relative Prices

Relative price trends mean that monetary policy cannot stabilize the nominal prices of all consumption categories. If prices are sticky, monetary policy must then trade off distortions within different categories; more weight should be placed on stabilizing prices for which adjustment entails greater distortions. With exogenous price stickiness, a simple model calibrated to U.S. data implies that slight deflation is optimal even absent money‐demand considerations. If price stickiness is endogenous (because of fixed costs of adjustment), small inflation or small deflation can be optimal, depending on whether demand conditions or price adjustment costs vary across sectors.