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The Welfare Cost of Permanent Inflation and Optimal Short-Run Economic Policy


  • Feldstein, Martin S


At a minimum, this paper should serve as a warning against too easy an acceptance of the view that the costs of sustained inflation are small relative to the costs of unemployment. If a temporary reduction in unemployment causes a permanent increase in inflation, the present value of the resulting future welfare costs may well exceed the temporary short-run gain. Previous analyses have underestimated the cost of a permanent increase in the inflation rate because they have ignored the growth of the economy and therefore the growth of the future instantaneous welfare costs. In the important case in which the growth of aggregate income exceeds the social discount rate, no reduction in unemployment can justify any permanent increase in the rate of inflation. Quite the contrary, if the inflation rate is above its optimal level, the economy should then be deflated to reduce the inflation rate regardless of the temporary consequences for unemployment.
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Suggested Citation

  • Feldstein, Martin S, 1979. "The Welfare Cost of Permanent Inflation and Optimal Short-Run Economic Policy," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 749-768, August.
  • Handle: RePEc:ucp:jpolec:v:87:y:1979:i:4:p:749-68

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    References listed on IDEAS

    1. Martin Feldstein & Jerry Green & Eytan Sheshinski, 1983. "Inflation and Taxes in a Growing Economy with Debt and Equity Finance," NBER Chapters,in: Inflation, Tax Rules, and Capital Formation, pages 44-60 National Bureau of Economic Research, Inc.
    2. J. Tobin, 1958. "Liquidity Preference as Behavior Towards Risk," Review of Economic Studies, Oxford University Press, vol. 25(2), pages 65-86.
    3. Franco Modigliani, 1977. "The monetarist controversy; or, should we forsake stabilization policies?," Economic Review, Federal Reserve Bank of San Francisco, issue Spr suppl, pages 27-46.
    4. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    5. Baily, Martin Neil, 1977. "On the Theory of Layoffs and Unemployment," Econometrica, Econometric Society, vol. 45(5), pages 1043-1063, July.
    6. Arnold Harberger, 1964. "Taxation, Resource Allocation, and Welfare," NBER Chapters,in: The Role of Direct and Indirect Taxes in the Federal Reserve System, pages 25-80 National Bureau of Economic Research, Inc.
    7. Hall, Robert E., 1976. "The Phillips curve and macroeconomic policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 127-148, January.
    8. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
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    Cited by:

    1. Buiter, Willem H., 2006. "How Robust is the New Conventional Wisdom? The Surprising Fragility of the Theoretical Foundations of Inflation Targeting and Central Bank Independence," CEPR Discussion Papers 5772, C.E.P.R. Discussion Papers.
    2. Martin S. Feldstein, 1999. "Capital Income Taxes and the Benefit of Price Stability," NBER Chapters,in: The Costs and Benefits of Price Stability, pages 9-46 National Bureau of Economic Research, Inc.
    3. Eduardo Wiesner, 2008. "The Political Economy of Macroeconomic Policy Reform in Latin America," Books, Edward Elgar Publishing, number 12913.
    4. repec:nrb:journl:v:22:y:2010:p:4 is not listed on IDEAS
    5. Michael R. Darby & James R. Lothian, 1983. "V. Conclusions: Conclusions on the International Transmission of Inflation," NBER Chapters,in: The International Transmission of Inflation, pages 491-524 National Bureau of Economic Research, Inc.
    6. Chuang, Shi-Feng & Huo, Teh-Ming, 2003. "A note on the optimum quantity of money," Economics Letters, Elsevier, vol. 79(2), pages 269-276, May.
    7. David Fielding & Paul Mizen, 2008. "Evidence on the Functional Relationship between Relative Price Variability and Inflation with Implications for Monetary Policy," Economica, London School of Economics and Political Science, vol. 75(300), pages 683-699, November.
    8. Hasan Bakhshi & Andrew Haldane & Neal Hatch, 1998. "Some costs and benefits of price stability in the UK," Bank of England working papers 78, Bank of England.
    9. T.P. Koirala Ph.D, 2010. "Welfare Costs of Inflation in Nepal: An Empirical Analysis," NRB Economic Review, Nepal Rastra Bank, Research Department, vol. 22, pages 57-68, April.
    10. Darrel Cohen & Kevin Hassett & R. Glenn Hubbard, 1999. "Inflation and the User Cost of Capital: Does Inflation Still Matter?," NBER Chapters,in: The Costs and Benefits of Price Stability, pages 199-234 National Bureau of Economic Research, Inc.
    11. repec:eee:reecon:v:71:y:2017:i:3:p:373-383 is not listed on IDEAS

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