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Price Stability vs. Low Inflation in Germany: An Analysis of Costs and Benefits

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  • Karl-Heinz Todter
  • Gerhard Ziebarth
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    Abstract

    We empirically investigate the costs and benefits of going from low inflation to price stability in the case of Germany. Recent empirical evidence on the sacrifice ratio suggests that the break-even point at which the permanent benefits of reducing the trend rate of inflation by 2 percentage points exceeds the temporary costs in terms of output losses is below 0.3% of GDP. We analyze the welfare implications of the interactions even of moderate rates of inflation with the distorting effects of the German tax system. Four areas of economic activity are considered: intertemporal allocation of consumption, demand for owner-occupied housing, money demand, and government debt service. We estimate the direct welfare effects of reducing the rate of inflation as well as the indirect tax revenue effects. We find that reducing the inflation rate by 2 percentage points permanently increases welfare by 1.4% of GDP. Finally, the optimal rate of disinflation is considered.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6170.

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    Date of creation: Sep 1997
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    Publication status: published as The Costs and Benefits of Price Stability. Feldstein, Martin, ed., Chicago: The University of Chicago Press, 1999, pp. 47-94.
    Handle: RePEc:nbr:nberwo:6170

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    1. 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.
    2. Robert E. Lucas, Jr., 1994. "On the welfare cost of inflation," Working Papers in Applied Economic Theory 94-07, Federal Reserve Bank of San Francisco.
    3. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-76, June.
    4. Attanasio, Orazio P & Weber, Guglielmo, 1995. "On the Aggregation of Euler Equations for Consumption in Simple Overlapping-Generations Models," Economica, London School of Economics and Political Science, vol. 62(248), pages 565-76, November.
    5. James Tobin, 1977. "How Dead is Keynes?," Cowles Foundation Discussion Papers 458, Cowles Foundation for Research in Economics, Yale University.
    6. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
    7. Daniel L. Thornton, 1996. "The costs and benefits of price stability: an assessment of Howitt's rule," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 23-38.
    8. Dean Croushore, 1992. "What are the costs of disinflation?," Business Review, Federal Reserve Bank of Philadelphia, issue May, pages 3-16.
    9. Laurence Ball, 1993. "What Determines the Sacrifice Ratio?," NBER Working Papers 4306, National Bureau of Economic Research, Inc.
    10. Mishkin, Frederic S., 1992. "Is the Fisher effect for real? : A reexamination of the relationship between inflation and interest rates," Journal of Monetary Economics, Elsevier, vol. 30(2), pages 195-215, November.
    11. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 540-42, August.
    12. Beaudry, Paul & van Wincoop, Eric, 1996. "The Intertemporal Elasticity of Substitution: An Exploration Using a US Panel of State Data," Economica, London School of Economics and Political Science, vol. 63(251), pages 495-512, August.
    13. Sheshinski, Eytan & Feldstein, Martin & Green, Jerry & Auerbach, Alan, 1978. "Inflation and Taxes in a Growing Economy with Debt and Equity Finance," Scholarly Articles 3203645, Harvard University Department of Economics.
    14. Mervyn A. King & Don Fullerton, 1983. "The Taxation of Income from Capital: A Comparative Study of the U.S., U.K., Sweden, and West Germany--The Theoretical Framework--," NBER Working Papers 1058, National Bureau of Economic Research, Inc.
    15. Otmar Issing, 1992. "Theoretical and empirical foundations of the Deutsche Bundesbank’s monetary targeting," Intereconomics: Review of European Economic Policy, Springer, vol. 27(6), pages 289-300, November.
    16. Jeffrey J. Hallman & Richard D. Porter & David H. Small, 1989. "M2 per unit of potential GNP as an anchor for the price level," Staff Studies 157, Board of Governors of the Federal Reserve System (U.S.).
    17. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
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