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

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  • Peter N. Ireland

    () (Boston College)

Abstract

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.

Suggested Citation

  • Peter N. Ireland, 2007. "On the Welfare Cost of Inflation and the Recent Behavior of Money Demand," Boston College Working Papers in Economics 662, Boston College Department of Economics.
  • Handle: RePEc:boc:bocoec:662
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    Keywords

    inflation; welfare cost; money demand; Friedman rule;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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