Costly price adjustment and the optimal rate of inflation

I analyse the optimal rate of inflation when prices are costly to change. As the costs of price adjustment are the main friction in the model, effects of inflation stem from the accounting role of money. Inflation increases relative price variability and reduces the average product of labour. This productivity distortion may be offset by a reduction in the desired real price. In general, the optimal rate of inflation is zero. This is consistent with early studies in monetary literature (LeBlanc, 1690, Jevons, 1875, Fisher, 1911 and Marshall, 1923), which concentrated on the role of money as a unit of account and argued that the goal of monetary policy should be price stability. Copyright © 2007 John Wiley & Sons, Ltd.