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Liquidity Effects and Welfare Costs of Inflation in an EndogenousGrowth Model

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  • C.K. Folkertsma
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    Abstract

    The paper has two subjects. The first subject is the development of a monetary general equilibrium model with en- dogenous growth. By combining the two-sector endogenous growth model and the limited participation approach, the model is able to explain the empirically observed liquidity effect of an expansionary monetary policy. The second subject is the effect of inflation on growth and economic welfare. It is shown that the traditional approach to measure the welfare costs of inflation may be misleading: It ignores the costs or benefits of the transition to the new steady state. This omission may bias estimates of the optimal degree and of the total benefits of disinflation. It is also argued that, once the transition is taken into account, the welfare gains of lowering inflation depend on the monetary policy rule and the fiscal response to disinflation. The two themes of the paper are related. Given that the welfare costs of inflation depend on the transitional dynamics, then simulating disinflation processes requires models with sensible short run properties.

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    File URL: http://www.dnb.nl/binaries/sr054_tcm46-146832.pdf
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    Bibliographic Info

    Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 54.

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    Length: 40 pages
    Date of creation: 2000
    Date of revision:
    Handle: RePEc:dnb:staffs:54

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    Related research

    Keywords: Monetary general equilibrium model; endogenous growth; welfare costs of inflation; monetary trans- mission; liquidity effects;

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    References

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    1. Cooley, T.F. & Hansen, G.D., 1991. "The Welfare Costs of Moderate Inflations," RCER Working Papers 266, University of Rochester - Center for Economic Research (RCER).
    2. David E. Altig & Charles T. Carlstrom & Kevin J. Lansing, 1994. "Computable general equilibrium models and monetary policy advice," Proceedings, Federal Reserve Bank of Cleveland, pages 1472-1505.
    3. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis.
    4. Antonio Ladron de Guevara & Salvador Ortigueira & Manuel S. Santos, 1994. "Equilibrium Dynamics in Two-Sector Models of Endogenous Growth," Working Papers 9403, Centro de Investigacion Economica, ITAM.
    5. repec:fth:simfra:93-03 is not listed on IDEAS
    6. Charles T. Carlstrom & Timothy S. Fuerst, 1995. "Interest rate rules vs. money growth rules: a welfare comparison in a cash-in-advance economy," Working Paper 9504, Federal Reserve Bank of Cleveland.
    7. Einarsson, Tor & Marquis, Milton H, 1999. "Transitional and Steady-State Costs of Disinflation When Growth Is Endogenous," Economica, London School of Economics and Political Science, vol. 66(264), pages 489-508, November.
    8. David Reifschneider & John C. Williams, 1999. "Three lessons for monetary policy in a low inflation era," Finance and Economics Discussion Series 1999-44, Board of Governors of the Federal Reserve System (U.S.).
    9. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
    10. Gomme, Paul, 1993. "Money and growth revisited : Measuring the costs of inflation in an endogenous growth model," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 51-77, August.
    11. Summers, Lawrence, 1991. "How Should Long-Term Monetary Policy Be Determined? Panel Discussion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 625-31, August.
    12. Martin S. Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 123-166 National Bureau of Economic Research, Inc.
    13. Alexander L. Wolman, 1998. "Staggered price setting and the zero bound on nominal interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-24.
    14. C.C.A. Winder, 1997. "On the construction of European area-wide aggregates: a review of the issues and empirical evidence," WO Research Memoranda (discontinued) 499, Netherlands Central Bank, Research Department.
    15. Michael Dotsey & Peter Ireland, 1994. "The welfare cost of inflation in general equilibrium," Working Paper 94-04, Federal Reserve Bank of Richmond.
    16. Bronwyn Hall, 1994. "R&D Tax Policy During the Eighties: Success or Failure?," NBER Working Papers 4240, National Bureau of Economic Research, Inc.
    17. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
    18. Wu, Yangru & Zhang, Junxi, 1998. "Endogenous growth and the welfare costs of inflation: a reconsideration," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 465-482, March.
    19. Kwanghee Nam & Thomas F. Cooley, 1998. "Asymmetric information, financial intermediation, and business cycles," Economic Theory, Springer, vol. 12(3), pages 599-620.
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    Cited by:
    1. C.K. Folkertsma & K. Hubrich, 2000. "Performance of core inflation measures," WO Research Memoranda (discontinued) 639, Netherlands Central Bank, Research Department.

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