A theory of low inflation in a non Ricardian economy with credit Constraints

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A theory of low inflation in a non Ricardian economy with credit Constraints

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Xavier Ragot

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Xavier Ragot

Abstract

This paper explores the relationship between the severity of credit constraints and long run inflation in a simple non Ricardian setting. It is shown that a low positive inflation can loosen credit constraints and that this effect yields a theory of the optimal long run inflation target with no assumption concerning nominal rigidities or expectation errors. Credit constraints introduce an un-priced negative effect of the real interest rate on investment. Because of this effect, the standard characterization of economic efficiency with the Golden Rule fails to apply. When fiscal policy is optimally designed, the first best allocation can be achieved thanks to a positive inflation rate and a proportional tax on consumption.

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Paper provided by PSE (Ecole normale supérieure) in its series PSE Working Papers with number 2005-20.

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Date of creation: 2005
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Handle: RePEc:pse:psecon:2005-20

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This paper has been announced in the following NEP Reports:

NEP-ALL-2005-07-25 (All new papers)
NEP-CBA-2005-07-25 (Central Banking)
NEP-DGE-2005-07-25 (Dynamic General Equilibrium)
NEP-FMK-2005-07-25 (Financial Markets)
NEP-MAC-2005-07-25 (Macroeconomics)
NEP-MON-2005-07-25 (Monetary Economics)

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