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Discretionary Inflation in a General Equilibrium Model

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  • Katharine S. Neiss

Abstract

This paper extends the Barro and Gordon (1983) model to a general equilibrium framework in which the costs and benefits to surprise inflation reflect the preferences, technology, and market structure of the economy. The benefit of such an approach is that we can relate the underlying features of the economy to the size of the inflation bias. In particular, it can be shown that an increase in the source of the monetary authority's incentive to inflate does not necessarily result in a worsened inflation bias due to offsetting changes in the cost of inflation. Furthermore, changes in the real interest rate affect the monetary authority's incentives and hence the discretionary level of inflation. Lastly, we can show that an increase in the labor share of national income worsens the inflation bias. The model also indicates the importance of a nominal rigidity, lack of policy precommitment, and a distortion for optimal monetary policy to be characterized by a level of discretionary inflation that exceeds the Friedman (1969) rule.

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Bibliographic Info

Paper provided by UBC Department of Economics in its series Old UBC Departmental Papers with number 9704.

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Length: 26 pages
Date of creation: Jan 1997
Date of revision:
Handle: RePEc:ubc:bcecwp:9704

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  1. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
  2. David Romer, 1991. "Openness and inflation: theory and evidence," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  3. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834.
  4. Faig, Miquel, 1988. "Characterization of the optimal tax on money when it functions as a medium of exchange," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 137-148, July.
  5. Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  6. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
  7. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476.
  8. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November.
  9. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  10. Roberto Chang, 1996. "Credible monetary policy with long-lived agents: recursive approaches," Working Paper 96-20, Federal Reserve Bank of Atlanta.
  11. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
  12. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
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