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The Optimal Inflation Target in an Economy with Limited Enforcement

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Author Info

  • James Bullard

    (Federal Reserve Bank of St. Louis)

  • Costas Azariadis

    (Washington University)

  • Gaetano Antinolfi

    (Washington University)

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 stationary 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, and 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 implied rate of inflation is positive, and the optimum implied 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 Society for Economic Dynamics in its series 2008 Meeting Papers with number 915.

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Date of creation: 2008
Date of revision:
Handle: RePEc:red:sed008:915

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
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Web page: http://www.EconomicDynamics.org/society.htm
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References

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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. Williamson, Stephen & Sanches, Daniel, 2009. "Money and Credit With Limited Commitment and Theft," MPRA Paper 20690, University Library of Munich, Germany.
  3. Stephen Williamson & Daniel Sanches, 2008. "Money and Credit with Limited Commitment," 2008 Meeting Papers 502, Society for Economic Dynamics.

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