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Money demand and seignorage - maximizing inflation

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Author Info
Easterly, William
Mauro, Paolo
Schmidt-Hebbel, Klaus

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Abstract

There is widespread consensus among economists that high inflation is often caused by the government's need to raise seignorage to finance high budget deficits. Depending on the shape of the money demand function, steady-state seignorage may follow a Laffer curve, where seignorage first rises and them falls with higher inflation. If so, a rate of inflation exists that maximizes steady-state inflation. Conventional estimates of the seignorage-maximizing rate of inflation often make use of the Cagan form, which implies a constant semi-elasticity of money demand with inflation. The authors develop a model that implies a variable semi-elasticity. They show that the elasticity of substitution in transactions between money and bonds is a crucial determinant of the seignorage-maximizing inflation rate and of whether the semi-elasticity of money demand with inflation increases with inflation. Individual country estimates and cross-country panel regressions based on annualdata from 11 high-inflation countries provide empirical support for their model. Relaxing the hypothesis of a constant semi-elasticity leads to estimates showing that, on average, the semi-elasticity of money demand with inflation increases with inflation. The results imply well-behaved Laffer curves that peak at plausible inflation rates; under Cagan form, there is no seignorage Laffer curve. In addition, the estimates based on the correct measure of the opportunity cost of holding money contrast starkly with implausibly high Laffer-curve maxima obtained when using conventional but wrong measures of inflation.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1049.

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Date of creation: 30 Nov 1992
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Handle: RePEc:wbk:wbrwps:1049

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Keywords: Economic Theory&Research Environmental Economics&Policies Inflation Settlement of Investment Disputes Access to Markets

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  4. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August. [Downloadable!] (restricted)
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  5. Rebelo, Sergio, 1991. "Long-Run Policy Analysis and Long-Run Growth," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 500-521, June. [Downloadable!] (restricted)
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  6. Dornbusch, Rudiger & Fischer, Stanley, 1991. "Moderate inflation," Policy Research Working Paper Series 807, The World Bank. [Downloadable!]
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  7. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March. [Downloadable!] (restricted)
  8. Calvo, Guillermo A & Leiderman, Leonardo, 1992. "Optimal Inflation Tax under Precommitment: Theory and Evidence," American Economic Review, American Economic Association, vol. 82(1), pages 179-94, March. [Downloadable!] (restricted)
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  10. Easterly, William & Schmidt-Hebbel, Klaus, 1991. "The macroeconomics of public sector deficits : a synthesis," Policy Research Working Paper Series 775, The World Bank. [Downloadable!]
  11. Bruno, Michael & Fischer, Stanley, 1990. "Seigniorage, Operating Rules, and the High Inflation Trap," The Quarterly Journal of Economics, MIT Press, vol. 105(2), pages 353-74, May. [Downloadable!] (restricted)
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  13. Lucas, Robert E, Jr & Stokey, Nancy L, 1987. "Money and Interest in a Cash-in-Advance Economy," Econometrica, Econometric Society, vol. 55(3), pages 491-513, May. [Downloadable!] (restricted)
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  14. Arrau, Patricio & de Gregorio, Jose, 1991. "Financial innovation and money demand : theory and empirical implementation," Policy Research Working Paper Series 585, The World Bank. [Downloadable!]
  15. Cooley, Thomas F & Prescott, Edward C, 1976. "Estimation in the Presence of Stochastic Parameter Variation," Econometrica, Econometric Society, vol. 44(1), pages 167-84, January. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Craig Burnside & Domenico Fanizza, 2004. "Hiccups for HIPCs?," NBER Working Papers 10903, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. De Melo, Martha & Denizer, Cevdet, 1997. "Monetary policy during transition : an overview," Policy Research Working Paper Series 1706, The World Bank. [Downloadable!]
  3. Leonardo Villar Gómez, 2004. "Inflación Y Finanzas Públicas," BORRADORES DE ECONOMIA 002852, BANCO DE LA REPÚBLICA. [Downloadable!]
  4. Janvier Nkurunziza, 2004. "How Long Can Inflation Tax Compensate For The Loss Of Government Revenue In War Economies? Evidence From Burundi," Development and Comp Systems 0409065, EconWPA. [Downloadable!]
  5. Joseph H. Haslag & Eric R. Young, 1998. "Money Creation, Reserve Requirements, and Seigniorage," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(3), pages 677-698, July. [Downloadable!] (restricted)
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  6. Dairo Estrada & Poldy Osorio, . "Effects of Financial Capital on Colombian Banking Efficiency," Borradores de Economia 291, Banco de la Republica de Colombia. [Downloadable!]
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  7. Amartya Lahiri & Carlos A. Vegh, 2005. "Output Costs, Currency Crises, and Interest Rate Defense of a Peg," NBER Working Papers 11791, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Raimundo Soto, . "Nonlinearities in the Demand for money: A Neural Network Approach," ILADES-Georgetown University Working Papers inv107, Ilades-Georgetown University, School of Economics and Bussines. [Downloadable!]
  9. Kaufmann, Daniel & O'Connell, Stephen A., 1999. "The macroeconomics of delayed exchange-rate unification : theory and evidence from Tanzania," Policy Research Working Paper Series 2060, The World Bank. [Downloadable!]
  10. Schmidt-Hebbel, Klaus & Serven, Luis, 1992. "Dynamic response to foreign transfers and terms-of-trade shocks in open economies," Policy Research Working Paper Series 1061, The World Bank. [Downloadable!]
  11. Willem H. Buiter, 2007. "Seigniorage," NBER Working Papers 12919, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Christopher Adam, . "The Transactions Demand for Money in Chile," QEH Working Papers qehwps60, Queen Elizabeth House, University of Oxford. [Downloadable!]
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  13. Brigitte Granville & Sushanta Mallick, 2005. "How best to link poverty reduction and debt sustainability in IMF--World Bank models?," International Review of Applied Economics, Taylor and Francis Journals, vol. 19(1), pages 67-85, January. [Downloadable!] (restricted)
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