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How costly is sustained low inflation for the U.S. economy?

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  • James B. Bullard
  • Steven Russell

Abstract

The authors study the welfare cost of inflation in a general equilibrium life-cycle model that includes households that live for many periods, production and capital, simple monetary and financial sectors, and a fairly elaborate government sector. The government’s taxation of capital income is not indexed for inflation. They find that a plausibly calibrated version of this model has a steady state that matches a variety of facts about the postwar U.S. economy. They use the model to estimate the welfare cost of permanent, policy-induced changes in the inflation rate and find that most of the costs of inflation are direct and indirect consequences of the fact that inflation increases the effective tax rate on capital income. The cost estimates are an order of magnitude larger than other estimates in the literature.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2004)
Issue (Month): May ()
Pages: 35-68

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Handle: RePEc:fip:fedlrv:y:2004:i:may:p:35-68:n:v.86no.3

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Keywords: Economic conditions - United States ; Inflation (Finance);

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  1. David Altig & Charles T. Carlstrom, 1991. "Inflation, personal taxes, and real output: a dynamic analysis," Working Paper 9102, Federal Reserve Bank of Cleveland.
  2. Abel, Andrew B, et al, 1989. "Assessing Dynamic Efficiency: Theory and Evidence," Review of Economic Studies, Wiley Blackwell, vol. 56(1), pages 1-19, January.
  3. Christina D. Romer & David H. Romer, 1997. "Reducing Inflation: Motivation and Strategy," NBER Books, National Bureau of Economic Research, Inc, number rome97-1, July.
  4. Orazio P. Attanasio & Guglielmo Weber, 1994. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," NBER Working Papers 4795, National Bureau of Economic Research, Inc.
  5. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  6. Kydland, Finn E, 1991. "Inflation, Personal Taxes, and Real Output: A Dynamic Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 575-79, August.
  7. Martin Feldstein, 1996. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Working Papers 5469, National Bureau of Economic Research, Inc.
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