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This paper studies the implications of an increase in the price of necessities, which disproportionally hurts the poor, for optimal income taxation. Our analyses show that, when the government is utilitarian and disutility from labor supply is linear, the optimal net nominal tax schedule is unchanged and the government expects households to supply more labor in order to secure their consumption expenditures. Quantitative analyses with convex disutility of labor supply reveal that, because of positive labor supply effects, keeping average tax rates constant suffices to optimally react to the asymmetric price shock. However, the poorest agents are expected to increase their labor supply the most. Thus, optimal income tax policy in response to asymmetric price changes does not prevent the disproportional decline in the indirect utility of poorer households.

The article focuses on the existing gap between theoretically optimal (often close to zero) and empirically observed (targeted by central banks, explicitly positive) rate of inflation. In order to reduce this gap, the article proposes some theoretical explanations of a positive rate of optimal inflation, the main cause of which are labor market frictions, financial market frictions and risk of achieving zero lower bound of nominal interest rates in the economy (also known as ZLB problem). Using a case-study approach, the article shows that ZLB factor contributes to a significant increase of optimal inflation rate in the countries with relevant experience. Consequently, ZLB factor provides a necessary, though not sufficient, argument in central banks' discussion concerning inflation target.

In this paper we generalise the standard optimal monetary policy literature as in Galí (2003) to the case of positive trend inflation. We present a simple framework that provides straightforward analytical results directly comparable with the standard case. Optimal monetary policy is strongly influenced by trend inflation and becomes less effective in controlling inflation as trend inflation increases. Moreover: (i) under discretion, optimal monetary policy may not be implementable (i.e., indeterminacy arises) and the efficient policy frontier worsens; (ii) under commitment, the degree of interest rate smoothing increases with trend inflation and the gains from commitment are highly sensitive to the level of underlying inflation. An ECB-like stability oriented monetary policy (i.e., 2% target inflation rate in the medium term) determines a substantial percentage loss in welfare with respect to a zero inflation target policy.

This paper presents a simple framework for analysing the operation and effectiveness of monetary policy in open economies in the spirit of aggregative approaches that are the mainstay of intermediate macroeconomic theory. Combining standard macroeconomic relations with precepts from international finance, it provides new lessons for the conduct of monetary policy under inflation targeting. It first confirms the classic Mundell‐Fleming result that monetary policy is only effective as a short run stabilization instrument under floating exchange rates, yet goes further in showing that countercyclical monetary policy is incompatible with inflation targeting under fixed exchange rates. Second, it highlights the importance of anchoring inflation expectations as a means of inflation control. Third, it suggests how central banks should react to changes in the monetary stance abroad. Lastly, it demonstrates how monetary policy should respond to productivity improvement at home under floating exchange rates.