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The optimal inflation target in an economy with limited enforcement

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  • Gaetano Antinolfi
  • Costas Azariadis
  • James B. Bullard

Abstract

We formulate the central bank's problem of selecting an optimal long-run inflation rate as the choice of a distorting tax by a planner who wishes to maximize discounted utility for a heterogeneous population of infinitely-lived households in an economy with constant aggregate income. Households are divided into cash agents, who store value in currency alone, and credit agents who have access to both currency and loans. The planner's problem is equivalent to choosing inflation and nominal rates consistent with a resource constraint along with an incentive constraint that ensures credit agents prefer the superior consumption-smoothing power of loans to that of currency. We show that the optimum rate of inflation is positive, and the optimum nominal interest rate is higher than the inflation rate, if the social welfare function weighs credit agents no more than their population fraction.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2007-037.

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Date of creation: 2007
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Handle: RePEc:fip:fedlwp:2007-037

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Keywords: Inflation (Finance) ; Deflation (Finance) ; Monetary policy - United States;

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Cited by:
  1. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2010. "Trend inflation, endogenous mark-ups and the non-vertical Phillips curve," wp.comunite 0065, Department of Communication, University of Teramo.
  2. Stephen Williamson & Daniel Sanches, 2008. "Money and Credit with Limited Commitment," 2008 Meeting Papers 502, Society for Economic Dynamics.
  3. Sanches, Daniel & Williamson, Stephen, 2010. "Money and credit with limited commitment and theft," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1525-1549, July.

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