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Optimal Inflation Policy

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  • Lawrence H. Summers

Abstract

This paper considers the problem of optimal long run monetary policy. It shows that optimal inflation policy involves trading off two quite different considerations. First, increases in the rate of inflation tax the holding of many balances, leading to a deadweight loss as excessive resources are devoted to economizing on cash balances. Second, increases in the rate of inflation raise capital intensity. As long as the economy has a capital stock short of the golden rule level, increases in capita intensity raise the level of consumption. Ignoring the second consideration leads to the common recommendation that the money growth rate be set so that the nominal interest rate is zero. Taking it into account can lead to significant modifications in the "full liquidity rule." Inter-actions of inflation policy with financial intermediation and taxation are also considered. The results taken together suggest that inflation can have important welfare effects, and that optimal inflation policy is an empirical question, which depends on the structure of the economy.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0354.

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Date of creation: May 1979
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Publication status: published as Summers, Lawrence H. "Optimal Inflation Policy." Journal of Monetary Economics, Vol. 7, No. 2, (March 1981), pp. 175-194.
Handle: RePEc:nbr:nberwo:0354

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Cited by:
  1. Christophe Chamley, 1981. "On the Infinite Welfare Cost of Inflation and Other Second Order Effects," Cowles Foundation Discussion Papers 598, Cowles Foundation for Research in Economics, Yale University.
  2. Carl E. Walsh, 1984. "Optimal Taxation by the Monetary Authority," NBER Working Papers 1375, National Bureau of Economic Research, Inc.
  3. Cavalcanti Ferreira, Pedro, 1999. "Inflationary financing of public investment and economic growth," Journal of Economic Dynamics and Control, Elsevier, vol. 23(4), pages 539-563, February.

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