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Inflationary Finance and the Welfare Cost of Inflation

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  • Barro, Robert J.

Abstract

This paper applies previous theoretical and empirical results on inflation and demand for money to a study of inflationary finance and the welfare cost of inflation. The amount of revenue generated by a steady inflation is derived as a function of the inflation rate and some underlying parameters. Empirically, the revenue-maximizing rate is on the order of 140 percent per month with the corresponding revenue approximating 15 percent of national income. It is argued that hyper-inflations become unstable when the revenue-maximizing rate is exceeded. Because inflation leads to higher transaction costs (resulting from greater payment frequencies and reduced use of "money" as a payments medium), there is a net social cost attached to inflationary finance. The model implies that marginal collection costs of inflationary finance exceed 50 percent for all positive rates of inflation-hence, alternative means of raising revenue should be socially preferable. The analysis also provides estimates of the social gain from moving to the optimum quantity of money as 1-3 percent of income.

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Bibliographic Info

Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 3451393.

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Date of creation: 1972
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Publication status: Published in Journal of Political Economy -Chicago-
Handle: RePEc:hrv:faseco:3451393

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  1. Friedman, Milton, 1971. "Government Revenue from Inflation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 79(4), pages 846-56, July-Aug..
  2. Stein, Jerome L, 1970. "Monetary Growth Theory in Perspective," American Economic Review, American Economic Association, American Economic Association, vol. 60(1), pages 85-106, March.
  3. Feige, Edgar L & Parkin, Michael, 1971. "The Optimal Quantity of Money, Bonds, Commodity Inventories, and Capital," American Economic Review, American Economic Association, American Economic Association, vol. 61(3), pages 335-49, June.
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Cited by:
  1. Pessoa, Samuel de Abreu, 2000. "Welfare Characterization of Monetary-Applied Models and Three Implications," Economics Working Papers (Ensaios Economicos da EPGE), FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil) 378, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  2. Siffat Mushtaq & Abdul Rashid & Abdul Qayyum, 2012. "On the Welfare Cost of Inflation: The Case of Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, Pakistan Institute of Development Economics, vol. 51(1), pages 61-96.
  3. Ferda Halicioglu, 2005. "Active And Passive Seigniorage Revenues: The Case For Turkey 1970-1997," Macroeconomics, EconWPA 0503010, EconWPA.
  4. Mladenovic, Zorica & Petrovic, Pavle, 2010. "Cagan's paradox and money demand in hyperinflation: Revisited at daily frequency," Journal of International Money and Finance, Elsevier, Elsevier, vol. 29(7), pages 1369-1384, November.
  5. Stella Raleva, 2012. "Cost Push Factors of Bulgarian Inflation (Bulgarian)," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, Bulgarian Academy of Sciences - Economic Research Institute, issue 3, pages 37-57.
  6. Easterly, William R & Mauro, Paolo & Schmidt-Hebbel, Klaus, 1995. "Money Demand and Seigniorage-Maximizing Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 27(2), pages 583-603, May.
  7. Stella Raleva, 2012. "Cost Push Factors of Bulgarian Inflation (English)," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, Bulgarian Academy of Sciences - Economic Research Institute, issue 3, pages 58-75.

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