Why Higher Trend Inflation Makes Monetary Policy More Costly in South Africa

Policy Brief 217 Most inflation-targeting central banks target a small but positive underlying rate of inflation, often called trend inflation1. Yet its appropriate level remains uncertain. The extended deliberation in South Africa to move from a 3 – 6% target band to a 3% point target (with a ±1% tolerance band) illustrates this tension. In our working paper (Trend Inflation and the Costs of Price Dispersion in a Fiscal DSGE Model), we examine the role of trend inflation in an economy and argue that, all else equal, lower trend inflation is better for the economy. Keywords: Trend inflation, monetary policy, price dispersion, Phillips curve, sacrifice ratio