Economics Letters 162 (2018) 116–123 Contents lists available at ScienceDirect Economics Letters journal homepage: www.elsevier.com/locate/ecolet A reevaluation of the macroeconomic effects of positive trend inflation Salaheddine El Omari Department of Economics, Al Imam Mohammad Ibn Saud Islamic University (IMSIU), Riyadh, Saudi Arabia highlights • We propose a refinement of Ascari’s (2004) model by introducing two theoretical important ingredients. • We propose a re-evaluation of the macroeconomic effects of non-zero trend inflation. • The omission of some important theoretical ingredients significantly distorts the results obtained to date. article info Article history: Received 15 December 2016 Received in revised form 7 July 2017 Accepted 5 November 2017 Available online 13 November 2017 Keywords: Re-evaluation Macroeconomic effects New Keynesian model Trend inflation Short-term proprieties Long-term proprieties Real frictions abstract To date, most of the papers which have examined the effects of trend inflation on the properties of New Keynesian model were based on relatively simple sticky-prices DSGE models and whose realism was sometimes questionable. In this paper, we re-evaluate the macroeconomic effects of non-zero trend inflation. Building on the model of Ascari (2004) as one of the most-cited papers in the literature on the effects of trend inflation, we show that the omission of some important theoretical ingredients signifi- cantly distorts the results obtained to date. We propose a refinement of this model by introducing two theoretical important ingredients, namely investment adjustment costs, and a roundabout production structure. Once we add these features to make the model more realistic, as commonly for medium-scale models, we find that the standard New Keynesian model without real frictions overestimates the short- term macroeconomic effects of a positive trend inflation rate and underestimates those of the long term. © 2017 Elsevier B.V. All rights reserved. 1. Introduction Most texts in new Keynesian macroeconomics with micro- foundations use models with nominal rigidities which are log- linearized around a particular stationary state: that at a null rate of inflation. However, the experiment of the post-war period in several industrialized countries shows a positive average rate of inflation justifying the inclusion of a non-zero steady-state infla- tion rate within a new-Keynesian framework. Several authors have attempted to document the effects occasioned by the presence of a non-zero steady-state inflation on the behavior of New Keynesian model. King and Wolman (1996) and Ascari (1998) were the first who studied the effects of trend inflation on the steady-state properties of the standard New Keynesian model. Later, Graham and Snower (2004a, b) and Karanassou et al. (2005) have studied the long- term relationship between inflation and output in such a frame- work. Bakhshi et al. (2007); Ascari (2004) and Amano et al. (2007) showed that a positive trend inflation seems to affect significantly E-mail address: el_omari.salaheddine@courrier.uqam.ca. the short-term properties of dynamic general-equilibrium models as well as their long-term properties. Ascari and Ropele (2007, 2009) argue that a trend inflation rate, even small, affects the optimal monetary policy and the dynamics of macroeconomic variables in general. Ascari et al. (2011) show that in the presence of a positive inflationary trend, the Taylor principle is enough to guarantee a determinate equilibrium. Their results, however, differ from those of Coibion and Gorodnichenko (2011) which show that a positive trend inflation can invalidate the Taylor principle and significantly alter the determinate equilibrium conditions. Cogley and Sbordone (2008) and Ireland (2007) show that the presence of a variable inflationary trend can increase the persistence of inflation. Up to now, the work that has explored the effects of trend inflation on the properties of New Keynesian model was based specifically on simple DSGE models and whose realism was some- times questionable. We argue that the omission of some important theoretical ingredients have distorted significantly the results ob- tained. Using, as an example, the model of Ascari (2004), this essay aims at three objectives. First, we reveal the major weaknesses of https://doi.org/10.1016/j.econlet.2017.11.009 0165-1765/© 2017 Elsevier B.V. All rights reserved.