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Welfare Costs of Inflation in Nepal: An Empirical Analysis

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  • T.P. Koirala Ph.D

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    (Nepal Rastra Bank)

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    Abstract

    This paper empirically examines the welfare losses arising from the currently rising inflation rate of Nepal using the method introduced into the literature by Bailey (1956) and the demand for real balance function put forward by Deaver (1970). Utilizing annual time series ranging from 1973 to 2009, the result obtained here supports the theoretical underpinning that the rise in inflation is leading to decrease in real balance and hence increase in welfare loss. It is also found that the rate of increases in welfare cost as a result of significant rises in inflation is sluggish. Further, the finding also leads one to conclude that the significant fraction of real income as welfare cost in the year 2010 corresponds to other factors affecting real balance rather than anticipated inflation. However, the evidence is consistent with the view that such cost may change under the relaxation of restrictions imposed corresponding to government’s motivation in raising inflation tax revenue (seigniorage), investment decisions of the economic agents, inflation uncertainty affecting the behavior of money holders and optimal rate of inflation specified.

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    Bibliographic Info

    Article provided by Nepal Rastra Bank, Research Department in its journal NRB Economic Review.

    Volume (Year): 22 (2010)
    Issue (Month): (April)
    Pages: 57-68

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    Handle: RePEc:nrb:journl:v:22:y:2010:p:57-68

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    1. Michelle R. Garfinkel, 1989. "What is an "acceptable" rate of inflation?--a review of the issues," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 3-15.
    2. Kevin Dowd, 1994. "The Costs of Inflation and Disinflation," Cato Journal, Cato Journal, Cato Institute, vol. 14(2), pages 305-331, Fall.
    3. William T. Gavin, 1990. "In defense of zero inflation," Working Paper 9005, Federal Reserve Bank of Cleveland.
    4. Feldstein, Martin S, 1979. "The Welfare Cost of Permanent Inflation and Optimal Short-Run Economic Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(4), pages 749-68, August.
    5. David Card & Dean Hyslop, 1997. "Does Inflation “Grease the Wheels of the Labor Market”?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 71-122 National Bureau of Economic Research, Inc.
    6. Eckstein, Z. & Leiderman, L., 1991. "Seignorage and the Welfare Cost of Inflation; Evidence from an Intertemporal Model of Money and Consumption," Papers, Tel Aviv 7-91, Tel Aviv.
    7. R. F. Lucas, 1989. "The Bank of Canada and Zero Inflation: A New Cross of Gold?," Canadian Public Policy, University of Toronto Press, vol. 15(1), pages 84-93, March.
    8. Tower, Edward, 1971. "More on the Welfare Cost of Inflationary Finance," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 3(4), pages 850-60, November.
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