Inflation persistence and monetary policy: A simple result

This note explores the interaction between monetary policy and structural inflation persistence in the context of a new Keynesian inflation model. We solve the monetary policy problem under discretion and find that optimal monetary policy is a function of the relative weight on the output gap in the welfare-theoretic stabilization objective, the responsiveness of inflation to fluctuations in the output, and the perceived degree of inflation persistence. Within our simple framework we find that underestimating inflation persistence always reduces inflation variability.