Controlling inflation: The infinite horizon case (Q1968770)

This paper models the problem of a Central Bank with infinite horizon who controls the nominal interest to minimize a weighted functional of inflation, of the nominal interest rate and of the total variation of interest rate. The idea is that the Central Bank wants to fight inflation and unemployment (by keeping the interest rate low) and wants to stabilize the nominal interest rate. The problem is reinterpreted as a two-players zero-sum stochastic differential game with stopping times between the desire to keep down inflation and the desire to keep down interest rates. The variational formulation of the game corresponds to a free boundary problem with two boundaries. The optimal stopping times are the times of intervention of the Central Bank for raising or lowering the interest rate.