In this case, real wages erode with inflation over the life of the contract and economy-wide employment is higher under moderate rates of inflation than it would be under a stable price environment. Critics of these views have countered that these stories are inconsistent with rational behavior on the part of households, since they imply that households are more willing to accept real wage declines through higher inflation than through a lower nominal wage, when rationality would dictate indifference. They also imply that firms lack the ability to adjust labor costs without altering the nominal wage. Nonetheless, to the extent that this short-run rigidity in nominal wages is immune to these criticisms, benefits to mild inflation may exist, although no studies currently reveal whether these benefits are sufficiently large to offset the additional welfare losses from higher inflation as described above. Finally, the optimal deflation implied by the Friedman Rule would require a zero nominal interest rate, which in practice is a lower bound with which economies have had little experience.
Japan is perhaps a notable exception.
Nonetheless, if the benefits of reducing the swings in the business cycle are perceived to be large, then central banks would need the flexibility to lower the interest rate to avoid recession. If the real interest rate is believed to be lower, or if the monetary authorities need greater flexibility to cut interest rates in times of economic weakness, then the optimal long-run average inflation rate would increase accordingly. They have taken concrete steps to lower the inflation rate and to ensure that it remains low. Research to date would support further reductions in the inflation rate to zero or to a mild deflation. Near Rational Wage and Price Setting and the Long Run Phillips Curve.