Optimal Inflation Targeting by Pedro Henrique Alves Pereira published by Banco Central do Brasil (4/2025).
This paper examines optimal inflation targeting, determining the best inflation target and policy response using a DSGE model with adaptive price-setting firms, in the form of a hybrid Phillips Curve. The results indicate a zero inflation target maximizes household welfare, as higher inflation increases volatility and economic inefficiency. As inflation targets rise, monetary policy must respond more aggressively to shocks and deviations from the target. Notably, the optimal policy does not react to output gaps. These findings highlight the importance of credible and well-structured monetary policies in ensuring macroeconomic stability and the growing costs of inflation (in terms of households’ welfare).
