Optimal inflation target may need to exceed two percent for welfare gains.
The study shows that traditional economic models may underestimate the optimal inflation target. By considering factors like labor market frictions and wage rigidity, the researchers found that the ideal inflation rate could be higher than previously thought, around two percent or more. Deviations from this target could lead to significant welfare costs due to effects on unemployment and output. Strategies like price level targeting or adjusting interest rates based on unemployment rates could help mitigate these effects and improve overall welfare.