Tradeoff between Inflation Stabilization and Growth Maximization

Abstract

This paper analyzes monetary policy implication in an endogenous growth model in which the average growth rate is inefficiently low and in which the capital accumulation technology is concave. This paper does two exercises. First, we derive the utility-based welfare criterion of the model. The welfare measure suggests that even if the natural rate of growth moves parallel to its efficient rate, the increase of inflation volatility may improve welfare through the increase of average growth. Second, we test this hypothesis numerically and show that in our calibrated model the tradeoff between inflation stabilization and average growth maximization exists. In addition, the tradeoff is resolved by highly growth-stimulating (investment stabilization) policy. The reason is the existence of concavity in the capital accumulation technology, through which investment stabilization rises average growth.