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On the Welfare Cost of Inflation and the Recent Behavior of Money Demand

  • Peter N. Ireland


    (Boston College)

Post-1980 U.S. data trace out a stable long-run money demand relationship of Cagan's semi-log form between the M1-income ratio and the nominal interest rate, with an interest semi-elasticity of 1.79. Integrating under this money demand curve yields estimates of the welfare cost of modest departures from Friedman's zero nominal interest rate rule for the optimum quantity of money that are quite small. The results suggest that the Federal Reserve's current policy, which generates low but still positive rates of inflation, provides an adequate approximation in welfare terms to the alternative of moving all the way to the Friedman rule.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 662.

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Length: 19 pages
Date of creation: 20 Apr 2007
Date of revision:
Publication status: published, American Economic Review, June 2009
Handle: RePEc:boc:bocoec:662
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