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Inflation taxes and inflation subsidies: Explaining the twisted relationship between inflation and output

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Abstract

This paper studies the nature of monetary policy in a cash-in-advance model with indivisible labor and with financial intermediaries that provide loans for working capital. Monetary policy occurs through money injections either directly to families or to financial intermediaries. Injections to families produce an inflation tax while injections directly to financial intermediaries provide an inflation subsidy that improves output, consumption, and welfare. This model helps explain why monetary policy based on growth in monetary aggregates can have ambiguous output effects, why central bankers usually prefer interest rate rules to monetary aggregate rules, and why estimated money demand equations tend to be unstable.

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  • George T. McCandless, 2008. "Inflation taxes and inflation subsidies: Explaining the twisted relationship between inflation and output," Journal of Applied Economics, Universidad del CEMA, vol. 11, pages 237-258, November.
    • Handle: RePEc:cem:jaecon:v:11:y:2008:n:2:p:237-258
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