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

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  • James Bullard
  • Steven Russell

Abstract

We study the welfare cost of inflation in a general equilibrium life cycle model with growth, costly financial intermediation, and taxes on nominal quantities. We find a stationary equilibrium of the model matches a wide variety of facts about the postwar U.S. economy. We then calculate that the inflation policy of the monetary authority has welfare consequences for agents that are an order of magnitude larger than existing estimates in the literature. These effects are large even at very low inflation rates. The bulk of the welfare cost of inflation can be attributed to the fact that inflation increases the effective tax rate on capital income.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1997-012.

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Date of creation: 1998
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Handle: RePEc:fip:fedlwp:1997-012

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

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  1. Andrew B. Abel & N. Gregory Mankiw & Lawrence H. Summers & Richard J. Zeckhauser, 1986. "Assessing Dynamic Efficiency: Theory and Evidence," NBER Working Papers 2097, National Bureau of Economic Research, Inc.
  2. David Altig & Charles T. Carlstrom, 1991. "Inflation, personal taxes, and real output: a dynamic analysis," Working Paper 9102, Federal Reserve Bank of Cleveland.
  3. 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.
  4. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
  5. 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.
  6. Christina D. Romer & David H. Romer, 1997. "Reducing Inflation: Motivation and Strategy," NBER Books, National Bureau of Economic Research, Inc, number rome97-1, octubre-d.
  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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