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Inflationary Finance and the Welfare Cost of Inflation

  • Barro, Robert J

This paper applies previous theoretical and empirical results on inflation and demand for money to a study of inflationary finance and the welfare cost of inflation. The amount of revenue generated by a steady inflation is derived as a function of the inflation rate and some underlying parameters. Empirically, the revenue-maximizing rate is on the order of 140 percent per month with the corresponding revenue approximating 15 percent of national income. It is argued that hyper-inflations become unstable when the revenue-maximizing rate is exceeded. Because inflation leads to higher transaction costs (resulting from greater payment frequencies and reduced use of "money" as a payments medium), there is a net social cost attached to inflationary finance. The model implies that marginal collection costs of inflationary finance exceed 50 percent for all positive rates of inflation-hence, alternative means of raising revenue should be socially preferable. The analysis also provides estimates of the social gain from moving to the optimum quantity of money as 1-3 percent of income.

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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 80 (1972)
Issue (Month): 5 (Sept.-Oct.)
Pages: 978-1001

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Handle: RePEc:ucp:jpolec:v:80:y:1972:i:5:p:978-1001
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  1. Stein, Jerome L, 1970. "Monetary Growth Theory in Perspective," American Economic Review, American Economic Association, vol. 60(1), pages 85-106, March.
  2. Friedman, Milton, 1971. "Government Revenue from Inflation," Journal of Political Economy, University of Chicago Press, vol. 79(4), pages 846-56, July-Aug..
  3. Feige, Edgar L & Parkin, Michael, 1971. "The Optimal Quantity of Money, Bonds, Commodity Inventories, and Capital," American Economic Review, American Economic Association, vol. 61(3), pages 335-49, June.
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